Writing two weeks ago about the unexpected intervention into Brazilian utility
rates, we predicted that the banking sector would be the next area that was
compelled to contribute to Brazil's "stimulus efforts". It has not taken long
for this to take place with Bradesco {BBDC4 BZ Equity} announcing a halving of
credit card interest rates on Monday evening (since which time the share price
has fallen by over 9%) and this morning reports that Banco Do Brasil will cut
fees for bank services significantly.

As we have described before, Brazil's state controlled banks have started to
dominate local credit granting in recent months as the private sector banks
have sensibly (if belatedly) started to tighten lending standards. August's
loan data showed that Private Sector Bank loans now total only 54% of total
loans, down from almost 65% in late 2008. This means that the Brazilian
government is in a position to exert maximum control via the state owned banks
over financial pricing for the banking system as a whole. The local equity
market has not been slow to get the message, with the IBOV index falling
sharply since the news broke on Monday evening.

Readers should be aware that the aims of "stimulus" are to support the
electorate and not the financial statements of public companies. To the extent
the needs of these two constituencies collide, the Brazilian government has
signaled that the needs of the electorate will be followed. 

Attached is a link to a panel discussion held at the Bloomberg EM Boot Camp on
September 27th, which Michael Shaoul attended. The discussion covers both EM and
debt markets.

http://www.bloomberg.com/video/emerging-market-debt-in-sweet-spot-chang-says-~Mm
xn0iUTYS6yBv4xEgxxw.html

Those struggling to reconcile stubbornly high unemployment with a buoyant
consumer discretionary sector and recovering real estate market can do no
better than to look at the radical reduction in the overall debt service burden
of households over the prior five years.

As the attached chart shows, overall debt service has fallen from an estimated
peak of 13.96% of total Personal Income at the end of Q3 2007 to 10.69% at the
end of Q2 (according to figures released this afternoon). This is close to the
record low reading of 10.60% recorded in 1983 at the start of the long 1980's
consumer boom. A combination of sharply lower interest rates and modest
deleveraging has radically changed the availability of cash flow for
discretionary purchases in recent years, a fact that has still not been fully
recognized by most observers.

Yet another "stimulus" induced rally took place in China's local A share market
this morning, with the SHASHR index gaining 2.60% on the back of rumors that a
number of market friendly measures, such as restraining the flow of new equity
issuance, would be announced. Even if such reports turn out to be correct we
would not expect the rally to last much longer than the 3.70% of September 7th,
which was sparked by reports of fiscal stimulus.

Regarding the latter we would note that China's government financing position
continues to deteriorate (although it remains far healthier than most western
nations). August's budget deficit reached -115 CNY, a record for this month and
-62 bln below last years figure. The trailing 12 month ma has now reached -84
bln, compared to -19.8 bln in August 2011. As can be seen on the attached chart,
the annual deficit is largely determined by the last 2 months of the year, so
we will have to wait a few months to determine how powerful the move into
deficit financing has been, but we would suggest that it has already moved
beyond the point that it could be treated as an irrelevant factor for setting
policy.

The decision of the FOMC to tie QE3 directly to US employment data means that
the market relevance of these over-followed but unreliable statistics is higher
than ever.

In our experience, Initial Claims data is generally "the best of a bad lot" when
it comes to estimating employment trends in real time, which is not to say it
is without its flaws. One of these is a seasonal tendency to track higher
between Easter and the mid summer and then track lower post-Labor Day (the more
influential BLS monthly data has suffered from the same flaw since 2009). For
instance after a poor spring and summer, Initial Claims fell by almost 9% from
September 16th 2011's reading of 414K to 377K at the end of the year.

This makes the next few weeks of Initial Claims quite important and this week's
report was certainly a step in the right direction. Claims fell -26K to 359K,
down from an elevated 385K last week and well below expectations of 375K. This
takes the 4 week ma of claims (see chart) down to 374K from 378K last week.
Should the recent seasonal pattern play out once more in 2012, this would
potentially take initial claims down to around 340K by the end of the year,
which would suggest somewhat better NFP additions than are currently expected
whether by the market or the FOMC. Of course this assumes that no genuine
economic disruption has taken place over the summer, but it also ignores the
more positive potential employment gains from a rebound in the new home market.
The latter has been an absent contributor to the cycle, and is one of the major
factors behind the lag in employment gains to date.

We continue our studies of local consumer confidence readings and local equity
markets with a look at the US. This morning's release of Conference Board
Consumer Confidence came in at 70.30, well above expectations of 63.1 and last
month's reading of 61.3. However, a surge of confidence following a strong
month in the equity market should not come as a great surprise, and this
month's reading still keeps confidence trapped in its post-crisis range between
40.90 (October 2011) and 72.0 (February 2011).

What is interesting is the degree to which the recovery in consumer confidence
has lagged that of the SPX index. The latter is closing in on its all time high
(and has surpassed it on a total return basis) while confidence is still 20
points below its average reading of 91.58 since the series commenced in 1970.
Moreover, consumer discretionary stocks have actually led the 42 month bull
market, comfortably outperforming the overall index.

This disconnect is highly unusual and helps explain the great reluctance of US
retail investors to participate in the current equity market. US equity mutual
funds have lost $550 bln of assets since the start of 2007, of which roughly
300 bln were redeemed during the current bull market. Our view is that
confidence is likely to start to narrow the gap to the equity market in the
months ahead (perhaps it will take a new all time high in the SPX to allow this
to happen), and that a breakout in consumer confidence would probably coincide
with a more pro-equity shift by the local retail population. This willingness
of US consumers to invest may coincide with some short term difficulties (as it
did in Q2 2010), but over the longer term we would welcome a more balanced view
of the local equity market by US consumers. - confidencespx.gif

Yesterday we wrote about Brazilian consumer confidence and its relationship to
the local equity market and this morning we will perform the same exercise on
Italy. Unsurprisingly confidence remains low at 86.2, close to the all time low
of 85.4 recorded in June and it would seem that the significant progress made
in the sovereign credit market has yet to be believed by the local population.
As a general rule an extreme low reading of consumer confidence that remains in
place after fundamental conditions start to improve is a bullish signal for
local asset prices.

Meanwhile the local equity market has shown some signs of life in recent weeks,
rallying from an all time low (the index starts in 1998) of 12,362 on July 24th
to 15,682 today, a 26.6% gain over a two month period. However, given the scale
of collapse that has taken place in equity values over the last 18 months (the
index was above 23,000 in February 2011 and peaked in 2007 at 44,364) it seems
likely that there is still some value on offer at current levels. -
italyconfidenceftse.gif

We note that as measured by the Bloomberg EU Financial Conditions Index,
Euro-zone conditions became positive for the first time since August 2007 on
Friday (see chart) and reached 0.018 this morning.

Of course this is something of a statistical quirk and the world scarcely looks
different with the BFCIEU at +0.01 or -0.01 but the very sharp improvement in
overall Euro-zone financial conditions in recent weeks is a meaningful
development. Prior to the launch of the LTRO, the BFCIEU was below -5 and at the
start of summer conditions were hovering around the edges of crisis readings
(below -2) before the anticipation and deliverance of the "Euro-fix" started to
greatly moderate stress.

Clearly problems regarding implementation remain, but political discussions are
currently being viewed with patience by financial markets which is a great
change from the febrile atmosphere of a year ago. - bfcieu.gif

We have periodically monitored Brazilian consumer confidence since the start of
the IBOV bear market, seeing that as a general rule, markets bottom only after
consumer confidence collapses.

As the attached chart shows, Brazilian consumer confidence has not come close to
doing that, and September's reading was fairly buoyant at 122.1. In part this
reflects the fact that although economic growth has stalled, local unemployment
continues to be muted at 5.3%. On the other hand actual job creation has been
sub-par in recent months (see last week's note), but this has not yet chipped
away at confidence.

The recent bounce in the local equity market will also have helped (consumer
confidence surveys are very closely related to investor sentiment), as will the
general belief that the interest cuts and fiscal measures enacted earlier this
year will help Brazil's economy avoid a process of sharp adjustment.

Unfortunately, this is typical of the state of affairs in the middle of a long
drawn out bear market. For instance the University of Michigan survey bounced
from 81.8 in September 2001 all the way up to 96.9 in May 2002 in a premature
celebration that the worst was behind the US recession. Our view remains that
Brazil faces a difficult few quarters and the fact that this survey suggests
that this will come as a surprise to many consumers, only means that the process
of adjustment will be a little more difficult. - brazilconsumerconfidence.gif

From our perspective the whole purpose of the "Euro-fix" is to buy time for the
economic process and sensible fiscal action to improve the underlying situation
in the crisis-countries. As we have argued before, this seems most likely to
take place in Ireland, where considerable progress has been made at least at
the level of stabilizing the banking system and local property market.

Spain lags this process by several quarters but at least there is finally some
sense that the bottom has been reached in terms of activity in its local real
estate lending industry. July's loan activity data was released this morning
and shows the number of new loans for houses running at 24,291, almost exactly
the same as June's level of 24,321. This is still -5167 loans less than the
level of a year ago but only 200 loans less than the average activity over the
last 6 months. This compares with annual draw-downs of over 20K in 2010 & 2011
and over 40K in 2008 & 2009.

Current activity is a mere 18% of peak loan activity of 129K recorded in
September 2005, which corresponds to our definition of a post bubble crash
whereby a haircut of roughly 80% can take place. By comparison US New Home
sales fell 81.4% between the peak in 2005 and 2011 low-point. As we saw in the
US, the low point in activity coincided with the middle of a long period of
repair for the local banking industry. Our sense is that something similar is
taking place in Spain at the current time and that the introduction of the LTRO
10 months ago actually marked the key turning point in the credit cycle. -
spanishhomemortgages.gif

Bloomberg Chart of the Day based on the summary of the Weekly Speculator.

Brazil published some conflicting data on employment today for while the
official unemployment rate remained low at 5.3%, the measured pace of monthly
job creation once more slowed substantially. The August reading of the CAGED
index showed 101K jobs being created, well below the consensus of 192K and last
month's print of 142K. This is the weakest August reading since 2003 (the data
is not seasonally adjusted) and is 89.5K below the reading of August 2011.
Furthermore this index has consistently delivered disappointing data over the
last 18 months, which increases the chances that August's shortfall is genuine
rather than a statistical blip.

If so this would suggest that the Brazilian employment cycle has reached the
point at which employers are unwilling to add to payroll but have not yet
decided to bite the bullet and start to fire workers. In part this is due to
relatively stringent labor laws and also in part due to the "soft landing
consensus" that has held back difficult managerial decisions. We doubt that
this balancing act can be continued for much longer and either Brazilian firms
will see enough improvement to justify a new wave of hiring or the more gloomy
scenario of a sustained rise in unemployment will come to pass. Unfortunately
history favors the latter path.

An interesting article that describes the significant compression of bond
volatility that has taken place in the run up to and in the aftermath of the
QE3 announcement.

As a general rule significant peaks in asset markets are often combined with a
collapse in volatility (this fact is well recognized in equity markets where
the VIX has unfortunately become an "asset class" in its own right). More
accurately periods of very low volatility tend to be followed by periods of
more chaotic trading, which themselves tend to be caused by falling prices.
Interestingly the last time treasury implied volatility measured by the MOVE
index (see chart) was below the current level was May 2007, which was the
early portion of the sub-prime crisis and the start of a treasury rally that took
yields down from over 5% across the curve to the ultra-low treasury curve of
today.

At the current time it is far more likely that any period of heightened
volatility would be caused by a rise rather than a fall in bond yields. We
would not say that volatility measures have yet reached the point at which a
clear danger signal is being generated but they have certainly reached an
abnormally low level. This combined with the massive flows that have been
allocated to fixed income and the equally massive issuance by corporations
(currently a record $1,074 bln YTD) and the government does seem to create a
potentially unstable combination that is out of kilter with the recent collapse
in the price of protection.

+------------------------------------------------------------------------------+

Bond Volatility Approaches Record Low as Fed Drains Convexity
2012-09-20 13:15:41.758 GMT


By Liz Capo McCormick
Sept. 20 (Bloomberg) -- The Federal Reserve’s decision to
hold borrowing costs steady into 2015 and buy mortgage debt each
month is reducing bond market volatility and demand for options
that hedge against changes in interest rates.
Mortgage bond holders often use swaptions, or options on
interest-rate swaps, to guard against swings in rates, which can
trigger changes in levels of expected mortgage refinancing and
the debt’s value. Losses on mortgage debt are greater than on
similar maturity and coupon Treasuries when interest rates rise
due to so-called negative convexity, which causes the bonds
duration, a measure of price sensitivity to interest-rate
changes, to simultaneously increase.
Bond market volatility is already approaching the lowest
levels since just before the global financial crisis. The fall
suggests the $40 billion monthly mortgage purchases and rate
guidance announced last week by the Fed may prove to be
successful in pushing investors into higher-returning assets, a
goal of the central bank as it seeks to spur economic growth and
lower unemployment.
“The combination of the strengthened forward rate guidance
from the Fed and a new round of quantitative easing is a
negative for volatility,” said Ruslan Bikbov, a fixed-income
strategist in New York at Bank of America Corp. “The perception
of a longer Fed-on-hold and the fact that the central bank is
taking negative convexity out of the mortgage-backed securities
market will cause volatility to decline.”

Volatility Gauge

Normalized volatility on three-month options for 10-year
U.S. interest-rate swaps, known as 3m10y swaptions, fell to as
low as 73.9 basis points yesterday, from 83.6 basis points on
Sept. 13, the day before the Federal Open Market Committee
announced new steps to ease monetary policy. The rate fell in
July to the lowest since June 2007. The gauge of volatility on
swaptions signals expectations for the pace of fluctuations in
swap rates.
In a swap, two parties agree to exchange fixed for variable-
rate payments over a set period. Swap rates are higher than
Treasury yields because the floating rate payments on a swap are
based on interest rates that contain credit risk, such as the
London interbank offered rate, or Libor.
The FOMC also said in its statement last week that “a
highly accommodative stance of monetary policy will remain
appropriate for a considerable time after the economic recovery
strengthens,” heightening speculation that debt purchase and
rates will prove prolonged.
Policy makers have kept their target rate for overnight
loans between banks in a range of zero to 0.25 percentage point
since December 2008. They extended their forward guidance on the
level into 2015 from 2014 last week.

Market Volatility

Bank of America Merrill Lynch’s MOVE Index, which measures
the outlook for the pace of debt price swings based on options,
declined to 57.5 basis points yesterday, the least since closing
at 56.7 basis points May 7. The index reached a high for the
year of 95.40 basis points on June 15. The record low of 51.20
basis points was in May 2007.
Another factor likely to depress volatility is that some of
the sellers of the mortgage securities to the Fed may choose to
replace the optionality lost in their portfolios in the process,
according to Neela Gollapudi, a New York-based strategist at
Citigroup Inc.
“The owners of un-hedged MBS positions who give the
securities over to the Fed will have to replace it somewhere
else,” Gollapudi said in an interview. “If they want to do
that in the options market, they would sell swaptions. The
likely impact on swaption volatility will not be negligible.”

Biggest Buyer

Normalized volatility on 3y10y swaptions is likely to fall
five to seven basis points over the next three months, Gollapudi
said. The volatility was 87.8 basis points today, down from
90.75 basis points at the start of the month.
The central bank’s asset purchases “removed a considerable
amount of assets with high convexity risk,” wrote Joseph
Gagnon, Matthew Raskin, Julie Remache and Brian Sack in a March
2010 Federal Reserve Bank of New York staff report, that
concluded the first round of quantitative easing lowered
borrowing costs.
The Fed may already be the biggest buyer in the agency
mortgage-bond market after starting in October to purchase new
securities with proceeds from its past acquisitions of housing-
related debt, including $1.25 trillion of home-loan notes
through March 2010. It has bought $305 billion of securities
under the reinvestment program, which it announced with the
first round of its so-called Operation Twist program for
Treasuries, where it swaps short- for long-term debt on its
portfolio.
Including the existing program in which the Fed is
reinvesting proceeds from its past purchase of housing debt into
the market, the central bank will be buying about $65 billion to
$70 billion a month, according to Bank of America.
“The Fed will be buying mortgages, and they’re not going
to hedge out any of the convexity,” Nancy Davis, director of
derivatives in New York at AllianceBernstein LP, said in a
telephone interview. “That is one reason why rate volatility
has been selling off aggressively. The Fed being on hold until
2015 is also volatility damping.”

For Related News and Information:
Freddie Mac weekly mortgage rates: NMCMFUS <Index> GP <GO>
Mortgage-bond stories: NI MBS <GO>
Agency MBS issuance data: IMBS <GO>
Government bailout programs: GGRP <GO>

--With assistance from Mary Childs and Jody Shenn in New York.
Editors: Dave Liedtka, Greg Storey

To contact the reporter on this story:
Liz Capo McCormick in New York at +1-212-617-7416 or
[email protected].

To contact the editor responsible for this story:
David Liedtka at +1-212-617-8988 or [email protected].
- moveindex.gif

Japan's regional export data continues to suggest that US demand for Japanese
products is holding up much better than either China or the EU. As the attached
charts show Japanese exports to the US reached ¥886 bln in August, a rise of
10.3% over the prior year. Exports to China were slightly higher at ¥966 bln,
but this represents a fall of -9.9% over the same period. Should this pace be
sustained the US will once more become Japan's primary export market sometime
in 2013. This sustained slippage of Japanese exports to China suggests that
domestic demand remains under significant pressure.

One additional factor that may start to depress Japanese trade with China is
the increasing tension over territorial claims. This morning's news included a
story describing the hoisting of a banner urging the death of Japanese citizens
over a local Audi dealership (others have merely offered discounts for those
wishing to trade in Japanese cars), which gives a sense of the bad blood that
is building over this matter (see link):

http://www.japanprobe.com/2012/09/18/audi-dealership-in-china-we-must-exterminat
e-the-japanese/

At least relations with Europe remain on a much more businesslike footing, but
here a combination of a sharply lower €/¥ cross rate (-10.5% for the year
ending August 31st) and a depression of local demand saw exports drop by
-22.9%. Even allowing for currency effects this is a steep drawdown, and we
doubt that the recent Euro-fix will result in a sharp improvement in the
immediate future. - japanchinausexports.gif - japaneuexports.gif

US Existing Home Sales provided yet another positive data point for the US
housing market, with total sales rising to 4.82mm, well above consensus estimates
of 4.56mm and last month's pace of 4.47 mm. This is the best level of sales
since the tax credit boosted month of November 2009 and setting aside that period
puts sales back to where they were in August 2007. Single Family Home sales
were 4.30mm, which ignoring tax-credits, was the best reading since July 2007.

Interestingly, single family inventory levels rose to 2.210mm units, but this
was caused by a surge in new listings to 555K. This should be taken as a sign
that the up-tick in the level of activity is encouraging sellers to seek to
take advantage and we see this as a positive development. Inventory measured
by months of sales actually fell to 6.2 months, and should fall below the
psychologically important half-year mark in the coming months.

Condo inventory remains much tighter, falling by 18% to 259K this month. This
is already at 6 months of sales and condo inventory looks likely to get quite
tight this winter when sellers traditionally pull listing from the market.

Going forwards, we would like to emphasize the degree to which seasonal
adjustments will start to favor the data. This may be particularly true given
the important role that financial buyers have been playing in housing activity.
These are likely to be much less sensitive to completing a sale in the winter
months than a traditional home-buyer, who may not want to move homes during
inclement weather. A smaller than normal seasonal dip in the data could
therefore generate some surprisingly strong headline sales during the dead of
winter that may give the impression of an even greater acceleration of activity
than would actually be occurring.

Over the last two weeks we have seen the ECB, FRB and BOJ announce important
new monetary policy and while we can quibble over the wisdom of each move (we
welcome the former and are less positive about the other two), it was hardly a
surprise to see international equity prices lifted strongly over this period.

The one clear exception to this rising tide remains the local Chinese equity
market, which enjoyed a strong one day bounce of 3.7% on September 7th
(following the announcement of fiscal stimulus) and then proceeded to grind
away this gain over the next couple of weeks. As can be seen on the attached
chart, this has produced a relative breakdown of the Chinese market versus the
overall MSCI Emerging Market Index (MXEF Index), with the ratio falling back to
its lowest level since May 2006. In absolute terms, the index remains about 2%
above its 2012 low, but looks likely to challenge this level soon enough. The
failure of this index to hitch a ride on the surge in international equity
prices is yet another warning sign that problems in the local economy run
deeper than is generally believed. - shashrandmxef.gif

Yesterday saw the publication of the strongest NAHB Sentiment index since June
2006 (see chart) with breakout data provided by the overall index (40), Present
Sales (42) and Future Sales (51) while Traffic remained in a rising trend (31).
This morning's housing start and building permit data suggests that after a
much better spring and summer selling season, homebuilders are finally starting
to ramp up new construction activity.

Overall housing starts were estimated at 750K in August, just below consensus
expectations of 767K, while July's data was revised slightly lower to 733K.
However, the shortfall took place in the volatile multi-family data and single
family starts reached 535K, which (ignoring the 2010 stimulus) is the best data
since October 2008 and 113K (26%) above the level of August 2011. Overall
building permits were estimated at 803K, just beating consensus of 796K and
roughly unchanged since July's 811K print. Single family permits (our favorite
metric out of this series) reached 512K and finally broke through the trailing
60 month ma, which we have been using as an indicator of recovery.

Of course none of this will come as a surprise to anybody (other than the BLS,
which estimates that -48K construction jobs were lost over the last 6 months).
The S&P 1500 Homebuilder Index {S15HOME index} has risen 77% since the start
of the year and 121% over the last 52 weeks. This week's data has therefore
probably been adequately discounted by this surge in prices, but we still
believe that the length and power of this housing cycle will come as a surprise
in the months ahead. - D-NHSPSTOT_Index.gif - M-NHSPA1_Index.gif -
nahbsept12.gif

The Bank of Japan announced this morning an unexpected increase in its asset
purchase facility of ¥10 trln ($126 bln) from ¥45 to ¥55 trln. To put this in
perspective the entire Japanese monetary base is approximately ¥121 trln (about
$1.55 trln)

It would appear that the decision of the FRB to introduce QE3 created an
intolerable risk that a further increase in the value of the JPY would take
place in the absence of a counter move by the BOJ to increase the supply of
JPY. As can be seen on the attached chart since late 2010 the BOJ has been
somewhat more proactive than is generally recognized. Although the initial
response to the crisis was minimal the response to the March 2011 earthquake
was considerable and roughly matched that of QE2 which was in operation at the
same time.

In fact the really tragic policy mistake was to rapidly drain liquidity in
early 2006. It is often forgotten that Japan was the first large modern economy
to confront "zero bound interest rate policy" via quantative easing, increasing
the local monetary base from approximately ¥60 trln to ¥114 trln between 2001
and 2006. The sudden reversal of this policy in 2006 undid all the progress
(which took place mostly in the valuation of local equity prices), and while
Japan could be said to have had a "good crisis" in 2008, this was largely
because it had experienced no boom in the prior decade to unwind.

At least the BOJ appears to have learned something from this episode, and would
appear to be determined not to be left behind in the race to reflate. Whether
this is enough to make Japan an attractive destination for investment capital
is another matter, and we would wait to see evidence that the BOJ's largesse is
starting to stimulate credit driven activity in the coming months. -
japanandusmonetarybase.gif

With QE3 now a fact of life, it is time to move on from discussions of whether
it was necessary and to start considering its effects on asset markets. With
very limited empirical data available the 8 month period of QE2 is the best
guide to follow, but it should be recognized that not only is FOMC policy
different this time around but so is the fundamental back-drop of economies and
the price levels and investor allocations within asset markets. Therefore
simply expecting QE3 and QE2 to have similar effects would seem to be an overly
simplistic view.

One area that will be of key interest is the response of US treasury rates.
Having collapsed in the run-up to QE2 these moved sharply higher following its
actual announcement. The greatest rally was seen in the mid portion of the
curve around 5 years, which was precisely the portion of the curve being
targeted by the FRB. This perverse response was largely attributable to the
fact that US economic data was much better than expected from November 2010 to
April 2011 (the Citigroup Economic Surprise Index hit a record high of 97.50 on
March 4th 2011, up from zero in late October 2010). This caused the 2 to 5 year
spread (green on chart) to widen substantially during QE2, and for the 1 to 2
year spread (blue) to widen through March 2011.

Therefore this time around the response of the US treasury market should also
be determined by economic data going forwards. The attached chart of the
CESIUSD shows that the odds are in favor of a reprise, it would appear that
data cycle bottomed in August and that the swing in seasonal adjustments will
allow a string of positive surprises to unfold as fall turns to winter.

However, this time around in addition to the fact that the FRB is purchasing
MBS and not Treasuries, we have the added use of "extended language" as a policy
tool. With the FOMC indicating that mid-2015 is the earliest yields will rise,
the 5 year portion of the curve is much more rooted to the front end than it
was 2 years ago. This time it is likely to be the longer term portion of the
curve that takes the brunt of the damage. As can be seen, the run up to QE3 and
its first day of existence have seen a substantial widening of the 5 to 10 year
spread (purple) and a modest rise in the 10 to 30 year spread (black). We would
not be surprised to see substantial further widening going forwards and there
is potential for the 5/10 year spread to challenge the 2011 high of 150 bp in
the weeks ahead.

We will break from publishing for the upcoming new year holiday and by the time
we return on Wednesday there should be a better sense of how the overall
response to QE3 has played out in the marketplace. - ustreasuryyieldcurve.gif -
cesiusd.gif

It is a good job that the FRB's mandate covers employment and not retail sales
or the QE3 party would never have got on the road. Readers may recall that it
is only 2 months ago that commentators were bemoaning the 2nd quarter official
retail data which showed three consecutive months of shrinking sales (circle on
chart) for the first time since 2008.

Absent in this analysis was the understanding that this is seasonally adjusted
data and that the poor 2nd quarter data followed a blow-out Q1. There was also
no confirmation of poor sales from the bulk of actual retail earnings reported
by public retail companies, making it almost certain that the Q2 slowdown in
sales was a statistical myth (and that the Q1 surge was equally misleading).
Indeed it has only taken 2 months to repair the Q2 draw-down and August's
robust rise of 0.9% (just above consensus) takes the data up to a new all time
high of $406.75 bln. This represents an annual growth rate of 4.67% over the
last 12 months, which is roughly in line with private sector data over this
period.

Interestingly the equity market proved a much better guide than official data
over the summer. The S&P 500 retail index (RELX) only suffered a modest decline
in the summer swoon and powered up to a new all time high this week. The
consumer discretionary sector has been at the heart of this bull market, a fact
that has not been widely recognized at least until now. We would expect the
latter to change going forwards. - usretailsales.gif - spretailindex.gif

See link for text:
http://www.federalreserve.gov/newsevents/press/monetary/20120913a.htm

Commenting on Chairman Bernanke's Jackson Hole speech, we reminded readers that
it always pays to take the Chairman at his word. Having outlined a firm belief
in the efficacy of "unorthodox monetary policy" in improving the economic
situation in the US (undoubtedly true in 2008/9, less so thereafter) and
highlighting the concern regarding US employment data, the release of a poor
BLS August Non-Farm Payroll report last Friday made a further round of asset
purchases significantly more likely to occur.

Today's FOMC statement confirmed our thoughts, while the lack of a dramatic
market response in the immediate aftermath shows that these were widely shared.
The FOMC has decided to immediately start purchasing $40 bln per month of
agency MBS, while keeping Operation Twist in place. This means the FRB will
growing its balance sheet for the first time since QE2 expired in July 2011
(see chart of historic FRB balance sheet) and bringing the holdings of MBS
securities somewhat closer to treasury holdings going forwards. In addition
the FOMC extended its guidance for exceptionally low rates to mid-2015.
Interestingly, the Fed Funds market for 2015 futures had already discounted this
move and rates actually ticked slightly higher following the statement.

We note that an unusually large proportion of the language was changed from the
prior statement, perhaps indicating the degree of soul-searching that lay
behind the move. The FOMC expressed a concern not so much that things were bad
today, but that "without further policy accommodation, economic growth might
not be strong enough to generate sustained improvement in labor market
conditions. Furthermore, strains in global financial markets continue to pose
significant downside risks to the economic outlook".

This defensive language perhaps shows the FOMC is mindful of the chorus of
criticism from some (including ourselves) that a further round of QE was
unwarranted and potentially harmful in the longer term. Looking forwards the
FOMC made it clear that labor market data will be the main determinant of
future asset purchases:

"If the outlook for the labor market does not improve substantially, the
Committee will continue its purchases of agency mortgage-backed securities,
undertake additional asset purchases, and employ its other policy tools as
appropriate until such improvement is achieved in a context of price stability."

We cannot remember a time that labor statistics were deemed to be so central to
FOMC policy, and this statement will only serve to encourage the already
unhealthy obsession with erratic BLS data (what we have termed "Non-farm
Nonsense") going forwards.

Putting those arguments to one side the question now is what happens next. MBS
spreads to treasuries were already tight, and can be expected to remain so. We
noted unusual strength in the homebuilding sector in yesterday's session and it
would seem that this has become a beneficiary of the new policy as have
regional banks.

Meanwhile the underlying treasury market received no new support from the FOMC,
and reflecting this 10 and 30 year yields have tracked somewhat higher in
recent sessions. The 30 year yield is currently challenging key resistance at
3.00%, while the 10 year note yield continues to be capped by its 200 day ma at
1.80%. It will be interesting to see if either yield can break out in the
coming sessions.

Gold had largely anticipated QE3 in recent sessions, moving strongly higher
since late August, but the metal managed to add a further $28 this session to
reach its highest level since February at $1,759. It remains to be seen if
today's move is enough to spark another round of inflows into the precious
metals arena. - frbbalancesheet.gif

In an unexpected move this morning, Russia's central bank chose to raise the
local refinance rate by 25 bp to 8.25%. This reverses the cut put into place
last December at the height of the Euro crisis. Although the bank referenced a
surge of local CPI above its target rate this summer, it is probably also
significant that today's decision follows a sharp moderation of concerns
regarding the Euro-zone. It would appear that last December's cut was more a
response to fears of Eurozone demand for Russian exports collapsing than a
response to internal economic developments and the recent "Euro-fix" has seen
an immediate shift towards tighter monetary policy. - russiarefinancerate.gif

Bloomberg TV Interview from last night. Focuses on energy, FOMC action and
domestically focused US equities.

http://www.bloomberg.com/video/marketfield-s-shaoul-on-fed-policy-oil-demand-YGIo5qdZRcaZMdrO15Coqg.html

We would like to bring our readers' attention to the sudden collapse in the
equity prices of Brazilian equities, which follows an unexpected announcement
that local utility rates would be cut by as much as 28% as part of the
government efforts to stimulate the economy. The idea being that lower utility
prices will stimulate consumer spending and/or reduce inflation. The response
of the market has been to trim 15-20% of the market cap of the companies at the
center of this new policy.

We see this as an unwelcome reminder that "government stimulus" often does not
follow the same aims as those investing in financial instruments. This is
particularly true in those portions of the world that have never truly left
behind the populist ideologies that had dominated all legislative activity
prior to the last couple of "decades of enlightenment". In Brazil's case the
banking system in particular should be concerned that it would be next on the
list, since the massive margins on consumer loans and growing default rates
would seem to make a tempting target at some point in the future.

Of course this sort of action is not limited to Brazil, a host of emerging
markets have a rich and tragic history of government intervention in local
industry. Our sense is that the "populist pendulum" has started to swing back
from the very benign policies towards a more intrusive and destructive role for
government and that this risk is largely unseen by global investors. -
brazilutilityindex.gif

India's Industrial Production data for July once again disappointed, with YoY
growth estimated at 0.1% compared to expectations of 0.5%. This takes the
trailing 12 month ma of the growth rate down 1% meaning that the industrial
economy has effectively stalled over the prior year.

Ironically this was treated as good news by the local equity market, since it
is assumed that lower industrial activity will heap pressure on the RBI to cut
interest rates further. This allowed the local SENSEX index to push up to the
18,000 level for the first time since March. This sort of contrary market
action is actually fairly normal during the early stages of down cycle when
investors cling to the comforting notion of a "soft landing". The concept that
collapsing production may cause a sharp deterioration in corporate earnings
does not factor into this thinking.

One other factor that we believe has aided the Indian market in recent months
is the fact that it is "not China". It would seem that to the extent investors
have started to limit their exposure to Chinese equities they have looked for
regional alternatives for their investments, or in dedicated BRIC funds to
favor the R&I rather than the B&C. This can be seen in the official data
tracking foreign inflows into Indian equities (see chart). These have now
reached $12.65 bln, the second highest reading for early September, despite the
steady stream of disappointing data and poor quality of local earnings seen so
far this year. - indianindustrialproduction.gif - indiainvestment.gif

The receding of Europe from the market's attention opens up more space
(literally in the case of the media) for the consideration of the state of the
Chinese economy. From our perspective this is unlikely to be a positive change.
The more you look beyond the comforting "big number" official statistics the
less there is to like, particularly if you focus on the state of actually
productive economic activity rather than politically driven public spending
(aka "stimulus").

Last night saw the publication of the quarterly Duke University Fuqua School of
Business/CFO Magazine Business Outlook survey. The China report (see link)
which is based on the response of 85 Chinese firms, shows a significant decline in
business confidence. In particular, expected earnings growth is now -6.4%, down
from -2.0% in May (when the PBOC was widely expected to be on the verge of
substantial monetary easing). We would also note that although anticipated
spending on R&D and capital remained positive, employment slipped into negative
territory in all three categories (permanent, temporary and out-sourced).
Dividends (public companies only) were also expected to shrink sharply.

As had been anticipated, the German Federal Constitutional Court ruled this
morning against a series of lawsuits seeking to bar German participation in the
ESM. German participation is still subject to a cap of €190 bln, and this limit
can only be raised by legislative approval (which by implication would still be
constitutionally permissible).

This decision brings our concept of a "Euro-fix" substantially closer to
reality, which means transforming an acute financial crisis in to a chronic,
long term fiscal issue. This still implies a great number of correct decisions
need to be made, but it also means that the 18 month period in which global
markets have been transfixed by the minutiae of the Euro-credit markets is
probably drawing to a close (although we would still expect to see a number of
brief flare-ups in the months ahead).

This is largely reflected in the change in stress indicators in recent weeks.
The overall Bloomberg Eurozone Financial Conditions index {BFCIEU Index} which
this morning has risen to -0.186 (see chart), its best reading since April
2010, right at the start of the Euro-crisis. The trailing 50 day ma is -1.22,
but this should move sharply higher as the older data drops out of the measure.
Euro-CDS spreads have also continued to rally with Italy, Ireland and Spain now
pushing on towards the 300 bp level and Portugal threatening to fall below 500
bp. We would use 200 bp as the upper end of normal, which means there is still
some way to go in this messy and painful unwind for those who crowded into the
Euro-crisis trade earlier this year. - eurocrisiscds.gif - bfcieuindex.gif

Sometimes "no news" can be treated as news and it is therefore worth noting
that Mexico's Industrial Production has remained robust through July 2012, in
contrast to most other major emerging market economies. July's data rose 0.5%
from June, causing the YoY pace to increase to 4.9%, somewhat above
expectations of 3.9% growth. The trailing 12 month ma is 3.91%, which is
probably a reasonably accurate guide for what is actually going on at the
current time. In other words Mexico continues to experience a steady pace of
growth at what appears to be a sustainable level, with total production now
above the prior cycle peak recorded in late 2008. - mexicoip.gif

China's budgetary data gets little attention in the financial media but it
strikes us that this is a mistake given the widespread belief that the local
and state government is likely to be required to undergo substantial stimulus
measures going forwards.

As can be seen on the attached charts although China's current fiscal position
is reasonably healthy it has started to deteriorate in recent months as revenue
growth has lagged well behind the growth of expenditure. Indeed only 4 out of
the last 12 months have seen government surpluses recorded and the cumulative
deficit over this period is approximately 1 trln CNY ($160 bln). This is hardly
alarming by US or European standards but it is perhaps a less healthy starting
position than most observers would consider.

August's data showed a deficit of -115.7 bln CNY, primarily caused by a surge
in total expenditure (red) to 902 bln CNY, a rise of 11.6% over the prior
period while total revenue (black) was 786 bln, up only 4.2% over the same
period. This pace of revenue growth lags the YTD cumulative pace of over 10%
suggesting either that the trend towards lower tax revenue growth that has been
place in recent months continued to be in effect. The concern for China is that
tax revenue could start to become quite sluggish going forwards while
government spending continues to become more extended, with a substantially
larger budget deficit being run over the course of this slowdown than is
currently anticipated. This situation bears monitoring going forwards. -
chinarevenueandexpenditure.gif - chinagovrevenuecumulative.gif

China's August data dump continued last night with the release of monetary data
and budgetary data, which will be addressed in a separate note.

Despite a relatively positive level of new loan issuance at 703 bln CNY (vs
consensus of 600 bln CNY) China's monetary data continues to show very tight
conditions in narrow money supply. M1 grew by 0.92% in August but this was
slightly lower than its growth a year ago and so the YoY change ticked slightly
lower to 4.50%. By comparison loans outstanding have grown by 16.10% over the
same period.

This combination has taken the ratio of loans outstanding/M1 outstanding up to
2.13, its highest level since 1999 and the steady rise of this metric in recent
months is an indication that ever larger amounts of credit creation are
required to stabilize local monetary conditions. Broad money measured by M2
remains rather more abundant, growing at 13.50% YoY but we believe that it is
M1 that is likely to correlate with actual economic activity and this continues
to grow far slower than the pace of most economic activity reported by China.
In other words 6 months into the monetary easing cycle monetary conditions
remain very tight and the PBOC seems to be in no hurry to address this
situation. - chinamonetarydata.gif

It is becoming increasingly hard to reconcile China's trade and transportation
data with the concept of an economy growing 7 to 8% a year. August trade data
showed total Exports growing by 2.7% YoY, while Imports shrank by -2.6%. Given
the volatility of monthly trade data we try not to make too much of any
individual reading but the point to grasp with Chinese trade is that there has
been a sharp deceleration of both imports and exports over the last 18 months
and we do not believe that there is any simple stimulus measure that can turn
this around, particularly on the export side where China is facing weaker
markets and diminished competitiveness.

Further support for the accuracy of trade data came out last week with the
publication of Port Freight data (see chart) which showed Annual growth of 2.9%
in July (August data is yet to be released), roughly in line with trade data.
Finally the publication of rail volume data this morning (available to Bloomberg users
at {NSN MA45Q01A1I4H <go>}) should act as a warning to those pinning hopes of
recent stimulus measures seeking to pour money into China's railways. Although
Passenger Volume grew by 6%, Cargo Volume shrank by -9.2% (we assume that
coal and iron ore account for a good portion of this slippage). Meanwhile Fixed
Asset investment in railways grew by 29.7%, suggesting that the return on capital
of much of this investment will be well below acceptable levels.


- chinatrade.gif - chinaports.gif

Writing in our Weekly Speculator in early August, we laid out what we saw as an
increasingly likely path towards a "Euro-fix" and one month later much of this
has indeed taken place. The ECB's plan of intervention covers most of the
salient points we were looking for and the market reaction suggests that it is
being taken far more seriously than the majority of policies introduced over
the prior 18 months of this crisis.

To a large extent this is because the scale of the problem has been steadily
whittled away over the prior 12 months and we would remind readers that there
have been three key stages to the crafting of a solution:

1. The silent increase in the size of the ECB balance sheet that started in
August 2011 under President Trichet, which helped buy time for more meaningful
action by his successor.

2. The reduction of local interest rates and introduction of the LTRO under
President Draghi. The latter has been a much more powerful strategy than most
people realize and led to an overall stabilization of Euro-zone funding markets
and the limiting of problem markets to specific and small number of sovereign
credits.

3. This week's announcement of planned intervention in both primary and
secondary markets for dislocated sovereign credit markets.

All of the above has left the "Euro-break up" trade looking extremely
ill-thought out. This has been belatedly recognized by those crowding into the
Euro-CDS market and recent weeks have seen a steady decline in local CDS rates.
In recent days this has developed into a rout with very sharp declines in the 4
rates we have concentrated on. We had set 400 as a breakthrough target for
Spain, Italy and Ireland and all three are now trading well below that level.
Even Portugal has now seen its CDS rate decline to 533 bp. The speed of decline
suggests that those exposed to this trade (which includes a large number of
macro themed hedge funds) are now under significant pressure to liquidate their
positions.

Given the opacity of this marketplace it is not possible to know the size of
positions being liquidated or have a sense of the damage being wrought, but for
those with a concentrated bet on the break-up of the Euro, the last few weeks
have been extremely painful, with significant losses being accrued at a time
when risk assets have posted decent gains. Whether this translated into just
another month of poor performance for a number of funds or genuine duress is
unclear at the current time, but the popularity of this trade and illiquidity of
the underlying market does make its unwind fraught with difficulty. -
eurocrisiscds.gif

Over the past week the majority of US Payroll data has suggested that overall
employment conditions have either stabilized or improved. Unfortunately, the one
piece of data that dominates discussion, policy and investing is the BLS
Non-Farm Payroll report and this produced a poor set of data for August.

Total Payrolls were estimated to have risen by 96K (130K consensus) and Private
Sector Payrolls by 103K (142K consensus), while July's numbers were revised
lower by -22K and -10K respectively. The headline Unemployment Rate fell to
8.1% from 8.3%, largely as a result of assumptions regarding the reduction of
the size of the workforce.

Our own metric for following Payroll data is the 12 month ma of Private Sector
payroll changes (see chart). This managed to rise slightly to 164.50K, since
the very weak data from August 2011 fell out of the calculation. Readers may
recall that a year ago the BLS estimated exactly zero jobs were added to
payrolls, causing President Obama to immediately demand an emergency stimulus
package of over $400 bln be passed (we are surprised no-one has thought to use
these embarrassing sound clips in the run up to the election). This data was
later revised up to 52K and was followed by a series of much stronger BLS data
over the next 6 months, caused in part (we believe) by a swing in seasonal
adjustment factors.

Our view remains that given the inherent volatility and inaccuracy of all US
employment data series they must be considered in a holistic manner and over a
reasonable time period. Followed in this manner the picture suggests that US
employment conditions are slowly but steadily improving and this has not been
changed by today's report.

We do understand, however, that most do not choose to follow our approach, and
that today's report will harden the view of those who believe that greater
monetary stimulus is required. The odds of the upcoming FOMC meeting ushering
additional "unorthodox" policy moves has risen as a result of this report, even
if the need or desirability of further FOMC action has not. -
nfpprivatesectoraug2012.gif

As expected the ECB announced its new proposed policy for stabilizing Euro-zone
sovereign markets. There are few surprises in the text and we note that the
guidelines explicitly allow for the purchase of government debt in the PRIMARY
market:

"Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment
programme or a precautionary programme (Enhanced Conditions Credit Line),
provided that they include the possibility of EFSF/ESM primary market purchases"

The ECB also promises that all purchases will be sterilized. Whereas in 2011 we
were very critical of the attempt to sterilize the purchases of sovereign debt,
this was because at that time there was a dearth of overall liquidity in the
Eurozone. Following the massive injection of the LTRO this is hardly the case
today, indeed overall financial conditions in Europe are fast approaching
normal with the BFCIEU index back to -0.589 today, and its 50 day ma back to
-1.343, its best reading since August 2011.

The Euro-CDS market has also reacted favorably with strong rallies in Italian,
Irish, Spanish and Portuguese credits. The first two of these are now below the
key 400 bp level with Spain looking likely to follow. Spain is still at 420 but
falling fast while Portugal continues to see a very powerful rally which has
taken its rate down to 574 bp.

+------------------------------------------------------------------------------+

Draghi’s Statement on ECB Outright Monetary Transactions: Text
2012-09-06 13:05:27.44 GMT


Sept. 6 (Bloomberg) -- The following is a reformatted
version of European Central Bank President Mario Draghi’s
statement at a press conference in Frankfurt today.

6 September 2012 - Technical features of Outright Monetary
Transactions

As announced on 2 August 2012, the Governing Council of the
European Central Bank (ECB) has today taken decisions on a
number of technical features regarding the Eurosystem’s outright
transactions in secondary sovereign bond markets that aim at
safeguarding an appropriate monetary policy transmission and the
singleness of the monetary policy. These will be known as
Outright Monetary Transactions (OMTs) and will be conducted
within the following framework:

Conditionality
A necessary condition for Outright Monetary Transactions is
strict and effective conditionality attached to an appropriate
European Financial Stability Facility/European Stability
Mechanism (EFSF/ESM) programme. Such programmes can take the
form of a full EFSF/ESM macroeconomic adjustment programme or a
precautionary programme (Enhanced Conditions Credit Line),
provided that they include the possibility of EFSF/ESM primary
market purchases. The involvement of the IMF shall also be
sought for the design of the country-specific conditionality and
the monitoring of such a programme.

The Governing Council will consider Outright Monetary
Transactions to the extent that they are warranted from a
monetary policy perspective as long as programme conditionality
is fully respected, and terminate them once their objectives are
achieved or when there is non-compliance with the macroeconomic
adjustment or precautionary programme.

Following a thorough assessment, the Governing Council will
decide on the start, continuation and suspension of Outright
Monetary Transactions in full discretion and acting in
accordance with its monetary policy mandate.

Coverage
Outright Monetary Transactions will be considered for future
cases of EFSF/ESM macroeconomic adjustment programmes or
precautionary programmes as specified above. They may also be
considered for Member States currently under a macroeconomic
adjustment programme when they will be regaining bond market
access.

Transactions will be focused on the shorter part of the yield
curve, and in particular on sovereign bonds with a maturity of
between one and three years.

No ex ante quantitative limits are set on the size of Outright
Monetary Transactions.

Creditor treatment
The Eurosystem intends to clarify in the legal act concerning
Outright Monetary Transactions that it accepts the same (pari
passu) treatment as private or other creditors with respect to
bonds issued by euro area countries and purchased by the
Eurosystem through Outright Monetary Transactions, in accordance
with the terms of such bonds.

Sterilisation
The liquidity created through Outright Monetary Transactions
will be fully sterilised.

Transparency
Aggregate Outright Monetary Transaction holdings and their
market values will be published on a weekly basis. Publication
of the average duration of Outright Monetary Transaction
holdings and the breakdown by country will take place on a
monthly basis.

Securities Markets Programme
Following today’s decision on Outright Monetary Transactions,
the Securities Markets Programme (SMP) is herewith terminated.
The liquidity injected through the SMP will continue to be
absorbed as in the past, and the existing securities in the SMP
portfolio will be held to maturity.

For Related News and Information:
Top economic stories: TECO <GO>



#<505319.2583362.3.1.0.0.25>#
-0- Sep/06/2012 13:05 GMT
- erocds.gif - bfcieuindex.gif

The ADP Payroll report comes somewhere between the Challenger Job Cuts and BLS
NFP reports in the economic pecking order. Of course this pecking order has no
real relationship to the underlying reliability of any of the data, it merely
reflects the degree of influence over the FRB, financial media and the
marketplace.

Therefore the very robust August report of 201K Private Sector jobs creations,
together with a 10K upward revision of July's strong data to 173K is unlikely
to be taken seriously unless it is reflected in Friday's official payroll data.
However, this does not diminish the fact that this independent survey is
starting to suggest that labor conditions have started to improve in recent
months, with the trailing 12 month ma of payroll change moving up to 178.7K,
the best level since March 2006. Given that over the medium to longer term the
ADP and BLS surveys tend to converge, this does suggest that appreciably better
BLS data can be anticipated at some point between now and the end of 2012.
Whether this improvement comes in time to stay the FOMC's hand over QE3 is in
the balance, but there is a growing risk for those chasing the "QE trade" that
the FOMC will under-deliver. - adppayrollaugust2012.gif

Of all the data released in "payroll week" the Challenger Job Cut Announcement
Survey is probably the least influential but this does not mean that it has no
utility for those tracking the overall employment environment. It is therefore
interesting to note that the August release showed 32239 job cuts, the lowest
reading since June 2000. Indeed 4 out of the last 6 readings since March 2012
have been below 40K, which normally coincides with a healthy employment market.
Although the trailing 12 month ma remains just below 50K, the very high
September 2011 print (116K) will fall out of the calculation next month,
allowing this trend indicator to fall sharply.

This in itself does not guarantee that new jobs are being created at anything
like a normal pace (although we suspect that more jobs are being created than
the BLS is measuring) and so unemployment remains on a slow downward path from
its elevated level. However, the dearth of job cuts does mean that the security
of those currently employed is significantly higher than it has been for most
of the last decade. This security is starting to be reflected in greater
consumer activity in general retail sales, car and housing purchases. -
challengeraugust12.gif

At its heart the current cycle has been dominated by a much more robust
recovery by the US retail consumer than most observers either felt was possible
3 years ago or even recognize today. Although today's Manufacturing data may
have been a little disappointing August car sales made up for some of this by
posting a significantly better level of sales than had been anticipated. Total
SAAR sales were 14.46 mm, above expectations of 14.20 and the best level of
sales since the "cash for clunkers" junket of August 2009. Excluding that dose
of fiscal steroids sales were the best since April 2008.

As the attached chart shows this takes sales roughly 2mm units above their
level of August 2011, a pace of improvement that is echoed by the strong
uptrend of the trailing 12 month ma which has now reached 13.88 mm units. At
the current pace of improvement car sales will reach the 16 mm level by the end
of spring 2013, which would represent a "normalizing" of car sales around
pre-crisis levels. With both the credit sensitive sectors of housing and new
car sales exhibiting unexpected pockets of strength over the summer months it
is increasingly hard to take on board the concept of a US domestic economy in
need of a further dose of radical monetary policy.

Of course the obsession of the FOMC with the level of employment (something
that cries out for much better tools of measurement that the awful and
antiquated statistics provided by the BLS, a topic that is sadly absent in
virtually all statements from the FRB) means that car and housing sales alone
will not determine policy, but they should at least be pause for thought in the
upcoming September meeting. - newcarsalesaugsust2012.gif

The August ISM Manufacturing survey continued to suggest a sluggish period for
Manufacturing sector with the overall index coming in at 49.6. Although this is
below the magic "50 level" it is not so by a significant amount and the fact
that this is the lowest reading since July 2009 is only true because the index
is 0.1 below the level of June 2012.

Mid-cycle dips below 50 are not actually that uncommon and were experienced in
1985 (low reading of 47.1 in May) 1995-6 (low point of 45.5 January 1996) and
1998 (low reading of 46.8 in December). On each occasion Manufacturing managed
to pick up steam again and continue to expand for several quarters. On the
other hand dips below 45 have led the general economy into recession and so the
decline in the ISM index has generated some concern in recent months. At
present the bulk of evidence suggests we are experiencing a mid-cycle slowdown
rather than a recessionary swoon, but we would need to wait for future
confirmation in the more important fall period.

In terms of this month's report, the worst data was provided by New Orders (red),
which continue to slip to 47.1 and Production (blue), which fell to 47.2. For obvious
reasons these are key metrics to watch going forwards. Overall Inventory build
(olive) was also positive at 53, a potential sign that Production has run ahead
of Orders in recent months, while Employment (pink) was just above neutral at
51.6 - ismjuly2012.gif

Brazil's Industrial Production for July rose 0.3% on a seasonally adjusted
basis, which was slightly better than consensus estimates of 0.2%. This caused
the YoY change in the NSA data to improve from -5.6% to -2.9% (see chart),
again just beating expectations of a -3.3% decline.

As welcome as any positive news will be in Brazil, this modest beat is not
statistically meaningful. The trend for IP remains firmly negative and this is
despite a tax reduction for vehicle purchases, which has boosted local car sales
significantly in recent months. With August originally meant to see the
expiration of tax cuts, a surge in local car purchases has taken place which
should feed through to industrial production later this summer (August sales
were up 28% YoY according to Fenebrave data, which should be confirmed tomorrow
by vehicle manufacturers).

However, the experience of similar moves in other countries is that fiscal
boosts to consumption succeed in the short term by bringing forwards sales,
leading to a nasty hangover once they expire (in Brazil's case the expiration
has been postponed, again mirroring the failed US fiscal boosts for housing and
car sales implemented in 2009 and 2010). Meanwhile last week's credit data
showed private sector banks on hold (total credit outstanding rose by only 1
bln BRL) and personal sector delinquency nudging back up to 7.9%. This strikes
us as the most important data series to watch in Brazil at the current time,
with the consensus view looking for a second half improvement in the data that
we believe is very unlikely to take place. - brazilip.gif - brazildefault.gif