For our final post of 2012 we will leave our readers with a question. Let us suppose the SPX index closes the year at exactly 1400 (it is at 1406 at the time of writing with 4 hours to go until the curtain comes down but we will be leaving early).

Looking into a crystal ball for the coming year we see that the expected return would take the index up to 1428 by the close of 2013, while a "great" year would take the index to 1470 and a "poor" year would see the index close 2013 at 1260. Would you as a reader find this to be an attractive investment opportunity?

Our assumption is that faced with this range of returns the vast majority of readers would take a pass on the US equity market for the coming year. And yet these are precisely the range of returns that are available to an investor in the current 10 year treasury market, where a 5% total return will be delivered by the 10 year yield falling to a record low 1.33% and a -10% loss should yields back up to a hardly alarming 3.21%.

Faced with this unappealing environment investors have sought to move out further in duration and/or down in credit quality. We have attached a table which provides readers with the range of yields and returns for the 30 year treasury bond and the Philippine 7.75% 2031 bond (which is the largest holding of the EMB ETF making up 4.37% of holdings). As can be seen there is no "free lunch" available in fixed income with the majority of popular holdings now offering poor expected returns with substantial embedded duration risk.

As for the equity market nothing is guaranteed. But at least there is not a mathematical ceiling pressing down upon potential returns and nothing like the danger of a hurried exit from a crowded trade should things not go to plan.

In general we refrain from making year end predictions but it would appear that most developed equity markets in the US, Europe and Japan offer substantially more attractive investment opportunities than their local treasury markets. In the case of emerging markets credit risk (particularly for corporate issues) can be added to the duration risk, while the popularity of this space with global retail investors is approaching the love affair with global growth equities 13 years ago.

Most accounts of China state that the PBOC has been easing monetary policy since the end of the first quarter, but a closer look at China's data shows that we have been witnessing an acceleration of credit and not liquidity in recent months. In other words this is not a return to the ultra-easy conditions of 2009/10 or even the manner in which relentless inflows from China's trade were recycled into domestic liquidity for much of the last decade.

Instead, whatever improvement in funding conditions has developed has been a result of powerful credit creation, both in local bank loans and the wider "social funding" category which includes the key corporate credit market, while overall liquidity creation has been almost non-existent.

There were some signs that the PBOC may have been starting to address the latter, but November's data (which was finally published last night) shows that the PBOC's balance sheet actually shrank by 242 bln CNY (0.83%), the 4th shrinkage so far in 2012. Over the last year the PBOC's balance sheet has grown by a mere 2.47%, which compares with growth of 10.3% a year ago and over 30% in the summer of 2008 when Chinese exports were growing very powerfully. The main cause of the slowdown in the PBOC's balance sheet growth is a total lack of FX reserve creation, which shrank slightly in November and have grown by 1% over the last 12 months. Since the slowdown in FX reserves is a function of weak export growth it is not clear that the PBOC has overall control over its balance sheet (unless it wishes to pursue the "unorthodox" policies of Western central banks).

As a result there has been a marked change in the relationship between China's monetary base (using the PBOC as an approximation of this) and the amount of Chinese loans outstanding (we do not have data for Total Social Funding which would be substantially higher). As can be seen on the attached chart the last decade can be split into three distinct phases:

2003 - 2008 Very fast liquidity creation and modest credit creation.
2009 - 2010 Very fast credit Creation and modest liquidity creation.
2011 - 2012 Very fast credit creation and no liquidity creation.

From 2003 to 2008 the ratio of the PBOC's balance sheet to Total Loans rose from under 0.40 to almost 0.70. This has since fallen back to 0.46, a level last seen in early 2005.

If readers want to understand what this means they should look at the attached chart which shows how the ratio of the FRB's balance sheet to total US bank loans outstanding fluctuated from 1981 - 2008. It is impossible to directly compare China today to the US 5 years ago (and we note that the ratio of liquidity to credit in the US was much lower in 2008 than in China today) but as a general point cycles fueled by rampant credit growth tend to become substantially more dangerous when local liquidity starts to stall. China would appear to have reached this point and it is not yet clear that the PBOC has the will or the tools to address this issue.

The November US Pending Home sales data shows that the strong momentum for US home sales continued into the post electoral period. The seasonally adjusted index reached 106.4 (January 2001 activity = 100), which is the strongest single month (excluding tax credit periods) since February 2007 (the month in the first sub-prime lenders failed). The trailing 12 month ma has climbed to 99.8, the highest level since October 2007 and this compares to a reading of 89.8 one year ago. As we have discussed before the vast majority of this pick-up in sales has taken place in the existing home market, with new home sales still extremely muted (although clearly recovering).

The NSA index confirmed the headline report with a print of 88.3, which is the best November reading since 2006. The 12 month ma of NSA sales has risen to 100.2, which is the highest reading since September 2007 (again ignoring tax credit periods). It would seem clear that the US housing market has finished 2012 in far better shape than most observers expected a year ago, and there remains scope for considerable improvement, particularly in new home sales, in 2013.

The Rousseff administration has been aggressive in its attempts to stimulate the Brazilian economy in 2012 with thus far little to show for it other than an increase in hope for a turnaround in 2013. What is clear, however, is that these stimulus efforts have started to have a marked effect on Brazil's fiscal position with reductions in consumption taxes trimming revenue while payments have been boosted in several areas.

The effect of this shift in fiscal policy can be seen in November's budget balance data, which showed a Primary (government balance before interest payments) deficit of -5.5 bln BRL, compared to an anticipated surplus of 5 bln BRL. This is the first Primary deficit since March 2010 and the largest deficit since December 2008's massive shortfall of -20.95 bln BRL. The Nominal (including interest payments) deficit for November was -21.8 bln BRL, the largest since September 2009. It is of course possible than some one off factors have exaggerated the deterioration in November's data but it is part of a clear trend towards wider deficits. The trailing 12 month ma of the Nominal deficit has reached -10.89 bln BRL, substantially wider than the -6.22 bln BRL reading seen in July 2011 and the widest since October 2009 which was generated by the collapse of revenue in the 2008/9 crisis.

The plan going forwards is for greater economic growth to bring Brazil's budget back into balance in the month's ahead but it is our general experience that fiscal stimulus proves to be far more expensive and far less effective than politicians expect at the time it is enacted. We would therefore expect a further deterioration in Brazil's budget balance going forwards. With net debt at 35% of GDP Brazil can afford some fiscal laxity, but perhaps not at the sort of bond yields (2.5% for the Brazilian 2024 USD bond) that are currently being awarded to it.

Evidence continues to mount that Ireland's housing market has turned the corner with November marking the 6th month out of the last 9 that prices have appreciated. Indeed the 1.1% MoM gain is the sharpest monthly rise since the tail end of the boom in September 2006 and although the YoY index still remains in negative territory at -5.2% this is a product of the very weak sales data generated in Q4 2011 and Q1 2012 which will drop out of the annual data very quickly from this point on.

Of course this still leaves prices at a very depressed level, with the national House Price Index at 69.10 (Jan 2005 = 100), only modestly higher than the June 2012 low point of 67.60. At its June 2007 peak the index registered 132, meaning prices dropped almost exactly 50% over a 5 year period, which counts as a full blown crash under any reasonable definition.

As we have seen before in other markets the turn in prices, at whatever level it is established, is a very important development, since it indicates that a two way market between buyers and sellers is starting to emerge. This creation of "price order" is a very important step to restoring confidence in the market which helps stimulate additional demand from investors and supply from the unwinding of legacy loan books. No doubt Ireland has a hard, long slog ahead but the odds of a surprisingly robust recovery have lengthened considerably in 2012.

Given the current obsession with the standoff in Washington it is unsurprising to see a dip in US consumer confidence metrics. The Conference Board survey for December showed confidence dropping to 65.10, below expectations of 70.0 and the lowest reading since June. Thus in the two months since the US election this poll has retraced all of its gain since December 2011, although it remains well above the sullen readings of the summer and fall of of 2011 when it ranged between 59.20 in July and 40.90 in October. This month's reading keeps the indicator within its recovering trend gives little sense that any dramatic shift in sentiment has taken place.

What is more interesting is that even against a backslide in general confidence the employment sub-category continues to improve. The "Jobs Hard to Get" survey generated a reading of 35.60, the lowest since September 2008, while the "Jobs Plentiful" survey remained above 10 for the third consecutive month, the first time this has occurred since confidence and activity collapsed in the summer of 2008. We suspect there is more to this improvement than a simple reflexive response to a lower official unemployment rate, and that the consumers being polled are starting to register a steady improvement in employment conditions.

US Census Bureau estimations of New Home sales have improved in 2012, but not to the degree that the published sales of public homebuilding companies would have led one to expect. In part we would imagine that this reflects the growing market share of public homebuilders, who have much better access to capital and actual product to sell than many of the small privately owned operators. In part however we suspect that the Census Bureau's arcane methodology simply fails to register much of the improvement that has taken place. As ever we choose to follow actual industry data when trying to judge the state of affairs, while continuing to comment on the official data as it is published.

November's New Home Sales report was in line with expectations with sales of 377K just missing consensus of 380K and total revisions totaling -1K. This means that sales have risen by around 15.3% over the last 12 months and have finally pushed through the trailing 60 month ma which we have been using as an indicator of recovery for several quarters (see chart). Total inventory rose slightly to 149K, but remains extremely low compared to other recoveries. Perhaps the one surprise in the data was the strength of prices, with the average rising to $299.7K. This took the trailing 12 month ma of prices up to $281.65K, the highest reading since February 2009 and perhaps indicating greater underlying strength than the sales data alone.

We have also attached an updated chart comparing New Home, Existing Home and New Car sales. The last two have recovered to around 85% of normal activity while New Home sales remain very depressed at 36% of December 2001's activity. A closing of this yawning gap seems likely in the months ahead.

Japan's Housing Start data continues to suggest a modest improvement in activity has taken hold in 2012. November starts were 907K on a seasonally adjusted annualized basis, an increase of 83K (10%) over the course of the last year. The trailing 12 month ma has nudged up to 876K, which is the highest reading seen since August 2009. This compares to pre-crisis activity of around 1200K homes and peak activity of 1800K last seen in the mid 1990's.

In other words Japan's residential construction remains very muted but looks to have turned the corner, with several years of abnormally low construction meaning that some build-up in local demand should have taken place. Interestingly rental construction has recovered somewhat faster than construction for sales (23.2% vs. 2.3% growth over the last year), while construction by home-owners splits this difference at 9.2%. Again this suggests a tentative recovery, placing Japan's construction industry close to where the US was a year ago. Whether we see the same sort of boost to local demand for housing take root in Japan during 2013 remains to be seen.

US Initial Claims data continues to suggest a sustained improvement in the level of job destruction. This week's data is the third time in recent months that the weekly data has been at 350K or below, and what appeared in early October to be a freakish "data-dip" (caused in part by tardy filings in California), now looks like the beginning of a new move down in the prevailing range.

Of course favorable seasonal adjustments are a partial force behind this process, and we have long argued that Initial Claims data should be able to establish itself below the key 350K level by the end of winter. This week's data takes that process a little ahead of schedule, with the 4 week ma of claims (which is finally rid of Superstorm Sandy's influence) falling sharply to 356.8, the lowest reading since March 2008.

Obviously the holiday season will make Claims data quite unreliable for the next couple of weeks, and so it will be late January before a reliable gauge of trend can be made using the 4 week ma, although the single week data will be free of holiday distortions somewhat sooner. Between now and then the December NFP report will set the tone for how the market views this issue, but we continue to believe that the US treasury market (and by extension high quality credit) is vulnerable to the risk of upside surprises in employment data going forwards.

Link to story:

http://www.nytimes.com/2012/12/28/opinion/global/the-flight-from-french-taxes.html?partner=bloomberg&_r=0

The land of the rising sun has had a myriad of false dawns since its financial markets peaked exactly 23 years ago this week.

The election of Shinzo Abe as premier has once more roused the cockerels, causing the JPY to weaken beyond 85 and the NKY index to face its way above 10,000, both of which are emotionally significant levels. As can be seen on the attached chart Japan's equity market has an unusual strong inverse relationship the JPY spot price (in general local equity prices and currencies tend to be positively correlated since both are influenced by foreign investor flows). This relationship has been particularly prevalent for the last 5 years during which a substantial strengthening of the JPY has taken place against a backdrop of extremely poor local market performance.

Premier Abe has been elected on a mandate that promises to address the undue strength of the JPY, and thus far the markets seem willing to take him at his word. In truth this adjustment has been long overdue. Although it is true that the BOJ has done somewhat less than either the FRB and the ECB in terms of quantative easing, this is largely because it has not had a domestic credit crisis to address.

A decade ago the BOJ was the only central bank to experiment with Quantative easing, which helped spark a strong rally in local financial assets in 2004 and 2005, which unfortunately convinced the BOJ to tighten policy aggressively in case inflation took hold. After mistakenly shrinking its monetary base in early 2006 the BOJ the then kept policy on hold through late 2008 since which time it has steadily added to domestic liquidity, with a brief burst of action following the tsunami of 2011 and some acceleration this summer. We would therefore argue that the recent strong move in both the currency and local equity market were somewhat overdue, and that both markets were primed to be pushed into action by political rhetoric.

This momentum may keep pushing both markets through the rest of the annual allocation period, but after this is complete it will require some concrete political and monetary policy shifts to cement these gains, let alone signal a genuinely exciting period for Japanese financial assets and the local economy. Even so this is a distinct improvement on the dismal viewing of recent years, and at the very least a range-bound two way market should develop as a result, which beats the torpor of 2011/2.

A great deal has been written in recent months regarding the remarkable increase in domestic US crude production. We recognize and are excited by this transformation, which we consider to be of material importance to the economy as a whole, but we have also maintained for several months that this surge of physical supply runs the risk of overwhelming the combination of physical and financial demand for crude oil. What may be excellent news for the economy as a whole may not be the boom for the energy sector which many observers currently expect to be the case.

We distinguish carefully between these two types of demand. The former is based on actual usage of crude oil and its derivative products while the latter is a function of the relentless flow of funds into the commodity arena, which is dominated in terms of market cap by crude oil and the wider energy complex. One way to track any divergence between these two is to look at the difference between the price of crude oil in the WTI market on which the Crude Oil future (CLA) is based and physical markets such as Wyoming and West Canada. The latter have been showing signs of weakness recently with West Canada in particular dropping sharply to as low as $44.23 last Friday, before bouncing to $53.90 today (see chart).

With physical markets under pressure there is finally some signs that the Oil Rig Count is starting to diminish. Total rotary oil rigs soared from under 179 in June 2009 (after collapsing from 442 in November 2008) to a peak of 1432 in August 2012. From August to November the count traded sideways but in recent weeks it has dipped appreciably. This week saw the count fall by 41, the largest one week drop (in nominal terms) since December 1992. Readers should recall that the dramatic plunge lower in natural gas prices was matched by a relentless cut back in the gas rig count (see chart) and so there is some reason to be concerned that a steady drop in rig counts will be matched by sustained softness in crude oil prices. Should financial investors start to become unnerved and reverse the direction of flows then the potential for much sharper reductions in both crude's price and the rig count would be considerable.

After collapsing in the summer of 2011 and 2012, Italy's local equity market (FTSEMIB index) has enjoyed a strong end to the year, rallying over 24% from its all time low of 12,295 recorded on July 31st to a level of 16,331 today. The
FTSEMIB is now up 8.15% for the year, and while this may lag the very strong performance of the DAX index (up 29.46%) it is a creditable performance given the collapse in value at the midway point of the year.

The same cannot be said of Italian consumer confidence, which fell to a record low of 84.9 in November and ticked higher to 85.7 in December 2012, compared to a level of 91.6 a year ago (which at the time was a record low). This refusal of consumer confidence to budge is reminiscent of what took place in the US during 2009, a period when financial markets (unlike financial commentators) were clearly signaling that the worst was behind us. Should Italy's local equity market make the sort of progress that we anticipate in 2013, we would expect consumer confidence to start to take note and at the very least to move back to the low 90's. Readers should recall that the surge in consumer confidence in spring 2010 actually coincided with the first significant correction to the current bull market, and we would not be surprised to see a similar pattern in the case of Italy. This means that we welcome the refusal of confidence to budge and do not expect to see any meaningful change until the upcoming election has been settled one way or another.

Buried under the rubble of attention directed towards the Fiscal Cliff was a decent November Personal Income report. This estimated Income growth to have been 0.6% for the month, well above expectations of 0.3% while October's data was revised higher by 0.1%. This makes November the strongest month for income growth since February and takes the level of Personal Income up to a new all time high of $13.53 trln, a rise of 4.14% over the last 12 months.

This means that Personal Income is now $900 bln above the prior cycle peak of $12.6 trln (recorded in May 2008), an increase of 7%, a factor which has allowed consumer spending to push on to new peaks of activity this cycle. However, as we have explained before, the substantial drop in the cost of servicing "financial obligations" since 2008 means that the amount of Personal Income available for discretionary purchases and savings has increased substantially more than the gross data would suggest.

The most recent data for the cost of servicing Financial Obligations showed them to be absorbing 15.74% of Personal Income, down from a peak of 18.94% in September 2007. Using this ration, "net" Personal Income (ie after Financial Obligations have been serviced) currently stands at $11.4 trln, an increase of 4.6% over the last year and $1.05 trln (10.6%) since the last cycle high of $10.3 trln recorded in June 2008.

We commented on Italy's robust export performance earlier this week and Spain's October trade data shows a similar pattern of rising exports and stable imports. Total exports for October reached €21 bln, a new all time high and a rise of 8.6% from October 2011. The trailing 12 month ma of exports also reached a new all time high of €18.5 bln, meaning that October's data is part of a general trend towards strong export performance. Imports were €22.57 bln, down -2% from a year ago, which is in line with recent data and makes sense given the drawdown in domestic economic activity. However, it should be noted that this decline is very modest compared to the collapse in imports seen in 2009/10 and also somewhat less than that which took place in the 2001/2 recession.

Meanwhile the monthly Trade Balance continues to improve, with October's deficit of -€1492 (historically a lucky number for Spain) being the smallest seen since July 1998. While we would not minimize the issues facing the Spanish economy the trade data is a useful reminder than even in deep recessions the pain is spread very unequally across an economy, allowing pockets of strength to remain intact.

Travel commitments meant that we did not publish the Weekly Speculator this morning and so we will update our view of gold in this daily note. As we had feared would prove the case, gold is limping towards the finish line for 2012, with the price of the metal collapsing in a manner which suggests some degree of liquidation is taking place.

Interestingly global ETP holdings of the metal have continued to rise, but at a slower pace in recent weeks. Total holdings reached an all time high of 84.61 mm oz yesterday, an increase of 11.67% since the start of 2012, and 16.31% since the start of August 2011 when the run-up to Jackson Hole and QE3 saw massive additional commitments of capital to gold and other precious metals. We assume that gold's inability to take advantage of these flows and break out to a new high indicates significant a significant supply imbalance in the physical market.

As for the price of the metal, today's decline of almost $30 (1.80%) has taken it down to $1,637, the lowest price since August 21st just as QE3 flows started to build. The metal is now up 4.75% YTD compared to the SPX, which has risen by 16.86% on a total return basis. From an emotional standpoint all eyes will now be on the $1563 level, which represents gold's closing price for 2011 (key support comes in somewhat lower around $1520). Gold has not had a down year since 2000 but the odds are growing that 2012 will break this remarkable trend of relentless appreciation.

One of our beliefs going into this winter has been that the significant participation of financial investors in the existing home market will make the seasonal effects somewhat muted. In more normal times, the onset of winter with its combination of poor weather and holidays has a marked effect on sales, but for the financial buyer looking to purchase homes with capital that has already been committed for this purpose this seasonal moderation of activity is far less likely to occur.

Thus were were not surprised to see the November Existing Home Sales report indicate a breakout to 5.04mm total sales on a seasonally adjusted basis, beating expectations of 4.90mm and representing a rise of 14.5% over November 2011. This is the fastest pace of sales (excluding tax credits) since July 2007. Single Family sales were 4.40mm (also the best since July 2007 ex-tax credit periods) which puts sales back where they were a decade ago at the start of the great boom in activity.

Meanwhile inventory shrank to 2.03mm total homes which is the lowest number since December 2001, out of which 1.80mm are for single family homes (also the lowest since December 2001). Even allowing for the typical seasonal drop off in listings this suggests a radical tightening of supply has taken place on a national basis in recent months. In terms of monthly sales single family homes inventory is at 4.8 months, which is the lowest since October 2005, however, should the pace of sales continue to increase this metric will start to fall back to levels unseen since the boom years of 2003-5.

Everything therefore points to greater construction being required going forwards, and an increasing propensity for house prices to appreciate. Although the homebuilding and construction material sectors have enjoyed torrid gains in 2012 we would expect that further progress will take place before this cycle has run its course.

We never spend much time on the quarterly GDP report since its data is generally over-publicized and in any case of far less analytical use than generally assumed. Nevertheless, rather like the monthl payroll report we are not blind to the psychological power that a number such as GDP has in forming the "common sense" view of how an economy is doing, which itself helps determine the commitment of investment capital.

This is particularly true at turning points in the data, and it may be that we are approaching one of these key moments in the current cycle. The revision to Q3 GDP raised the pace of "real" GDP to 3.1% from 2.7% (annualized QoQ change), making the last quarter the 3rd strongest since Q2 2007, and the largest Q3 growth since 2005. This nudges the data closer to the point that a genuine breakout could take place.

We have generally preferred to use the Nominal GDP series (since this eliminates the distortion of the measurement of inflation and generally correlates better to actual economic activity and financial prices, which themselves are nominal). As can be seen on the attached chart this measure has fluctuated between 3.80% and 4.5% since Q2 2010, making the current recovery (at least as measured by GDP) muted in comparison to those which preceded it, but again meaning that any further uptick would cause the data to breakout into more "old normal" territory.

Even allowing for this, the FDTR being set at a level 375 bp below GDP growth and kept there for several years is without precedence (the FDTR lagged GDP by a significant margin last cycle, but for most of the period it was being nudged steadily higher). The bond market has been extremely patient with this state of affairs, and the 30 year yield remains around 100 bp below nominal GDP at the current time. We expect both the 30 year bond yield and Nominal GDP to push higher in 2013 while the FDTR remains rooted to the floor.

Meanwhile domestic liquidity continues to build at a much faster rate than nominal GDP, with M2 growing in the 7 to 10% range for most of the recovery (with the exception of a dip below 5% 2010 and early 2011). This has caused the ratio of outstanding M2 to GDP to breakout to a new all time high of 0.65, up from a level of 0.53 in Q2 2008. As with so many of the effects of recent monetary policy, this build-up of liquidity has gone unreported, and we would admit that up to this point it has had little effect.

However, over the course of the cycle this may not remain the case and this massive store of liquidity represents a potential accelerator of economic (and particularly investment) activity should confidence ever build in the rest of this cycle. Quite why the FOMC felt it necessary to extend its treasury purchases last week (and for investors to continue to crowd into fixed income investments in response) will be one of the great questions for economic historians looking back on this cycle in years to come.

Initial Claims data for the week ending December 15th showed a bounce in claims up from last week's depressed level of 344K (revised up by 1K) to 361K, in line with expectations. This is still a decent report, which suggests that once the storm related distortions are eliminated Initial Claims data has shown a steady improvement since the summer. This can also be seen in the Continuing Claims report which reached 3125K this week, the lowest level since July 2008.

The trailing 4 week ma of Initial Claims (see attached chart) fell to 381K, but this metric still includes one elevated data-point from the storm and can be expected to fall to around 365K (or lower) by next week. We still maintain that this metric could fall below the key 350K by the start of Spring, when seasonal factors may make the progress a little harder going forward. This improvement in Claims has taken place against a backdrop of silence, and to the extent it is recognized it is then dismissed on the basis that corporations are still reluctant to hire. Although the latter is partly true, it does not eliminate the effect of the steady downward trend in Claims, which suggests that the key unemployment report should continue to show improvement in the months ahead and stay well ahead of the FOMC's schedule for reaching 6.5% in late 2015.

The NAHB Homebuilder Sentiment Index for December was slightly better than expected at 47 versus 46 consensus, while November's reading was nudged down to 45. What really matters however is the trend of the data, which shows a powerful transition over the course of 2012 from depressive level of 21 in December 2011 to a near normal 47 today. Indeed, both Current and Future sales have now moved above the key 51 level, indicating "normal" levels of activity, while Traffic still remains muted at 36.

We believe that the latter is really indicative of a qualitative shift in home-buyer traffic, with a greater proportion of visitors to sales sites being serious about purchasing a property, thus allowing muted traffic to support a normal level of sales activity. Again this is understandable of the crisis and recovery in housing, and we should start to see the Traffic and Sales data start to converge later in the cycle.

One area of the Chinese economy that has not shown improvement in the last few months is FDI, with November marking the 12th month out of the last 13 in which this measure has fallen on a YoY basis. November's drop was -5.4% from that of November 2011, taking the trailing 12 month ma down to -4.1%. At $100 bln YTD FDI is still strongly positive, but given the purported growth rates of much of the Chinese economy it has become a significantly weaker force within the domestic Chinese economy in recent months.

India continues to see a fascinating tussle between the RBI's monetary policy, which remains tight, and the willingness of foreign investors to provide additional liquidity into India's equity and fixed income markets.

For a guide to the former we follow the daily Repo activity of the RBI which publishes its activity each morning. As liquidity in the banking system tightens the RBI is required to provide additional funds (red on chart) while periods of abundant liquidity see the RBI drain the excess through repo activity (blue on chart). It should be noted that liquidity needs are very seasonal in India, typically peaking at the end of the fiscal year (March 31st) when corporations typically want to show maximum cash on their final balance sheet. The end of December also sees a mini-version of this process, while mid-September generally sees minimal corporate cash draw-downs.

As can be seen daily repo injections reached 1.4 trln INR this morning, the highest since late March while the 50 day ma moved to 833, taking it back to where it was in mid July. We would expect to see a further deterioration of liquidity going into the new year, even though we note that the RBI is widely expected to reduce the reserve requirement for Indian banks.

Meanwhile foreign flows continue to rush into India, with YTD net equity purchases reaching $22.35 bln. Although we doubt that the 2010 record of $29.32 bln will be matched flows could easily top $25 bln for 2012 as a whole. These flows have been crucial not only in terms of the local equity market's performance (up 24.5% YTD after falling 24.6% in 2011) but also for the general availability of liquidity within India's financial system, particularly given the significant deterioration in India's trade balance over the last few quarters.

Interview concentrates on Italy, Germany, Canada and the US.

http://watch.bnn.ca/#clip828131

We have argued in recent weeks that Italy's equity market has become a logical destination for investment capital and some support for this view was provided by October's trade data which was released this morning.

This showed Italy's monthly trade surplus moving up to €2.45 bln, taking the trailing 12 month ma up to €529 mln, its highest level since early 2003. Most importantly the trade balance has turned positive due to a surge in export activity (up 12% YoY) rather than a collapse in imports (up 0.9%).

Indeed October's exports totalled €36 bln, a record for this month in the NSA data, while the 12 month ma moved up to €32.4 bln, which is also a record for this metric. Thus while Italy's overall GDP may show the country to be in recession its export sector appears to be in boom territory. Even Eurozone exports increased by a respectable 6.7% YoY, and the only notable weakness came from exports to China which slumped -10%.

Interview concentrates on European equity markets and Apple.

http://www.bloomberg.com/video/shaoul-european-economy-not-as-bad-as-you-think-AD4dO2YWRN~ynIDxFv2c_g.html

The attached article was based on our note regarding the Metropolitan Opera's issuance of a bond offering (which was successfully closed yesterday paying a coupon of 4.52% for 30 years) together with a follow up conversation with the author.

http://www.nytimes.com/2012/12/15/business/risk-creeps-up-in-long-term-bonds.html?partner=bloomberg&_r=0

The FRB released the Q3 update to its Financial Obligation and Debt Service ratios late yesterday afternoon and although the data is not a surprise it is still worth reiterating the radical change in the US Homeowners's and Consumers' position over the last 4 years.

As the attached charts show the overall Financial Obligation ratio (which estimates how much personal disposable income is required to cover the average expenditure on home mortgage, consumer debt, automobile lease payments, rental payments on tenant-occupied property, homeowners’ insurance, and property tax payments) has fallen to a new 29 year low of 10.61%, down from a peak of 14.05% in Q3 2007. Since Personal Income is estimated at $13.4 trln this represents a reduction of this burden of around $450 bln a year. The more narrow Home-owner's Mortgage Debt Service Obligation fell to 8.90%, taking the measure back to where it was in Q3 2001 (and Q4 1984). This ratio peaked at 11.30% in September 2007.

This goes a long way to explaining how sluggish GDP can coexist with reasonably robust consumer expenditure and a recovering housing market. Of course as any fixed income investor will be aware there is a cost to this policy, which arguably has been a much more radical re-distributive force of after tax income (since fixed income securities are much more prevalent in wealthy investors portfolios) than any of the taxation changes currently being wrangled over in Washington.

We would imagine that the current data probably marks or is very close to the low point in these ratios. Looking ahead interest rates are much more likely to rise than fall and home prices are likely to continue to appreciate. This would be a typical pattern for a strengthening recovery and would be accompanied by a rise in total personal income and employment. After a number of quarters we would expect to reach the point at which the ratio would start to question the ability of US consumers to juggle their financial obligations and consumer purchases, but at the present time the collapse in interest rates and home prices in recent years represents a crucial stimulative force for the domestic US economy.

We generally find the official US Advance Retail Sales data much less useful than the private sector data which comes out earlier in the month but since the official data is widely followed it does have influence over market sentiment towards this key portion of the US economy.

November's data was reasonably solid, with total sales growing by 0.3% compared to expectations of 0.5%. Since this shortfall was caused by lower gasoline purchases (itself a reflection of lower gasoline prices nationally), this report will be seen to be in line with expectations. Retail Sales Ex Autos and Gas grew 0.7%, with October's data revised slightly higher from -0.3% to -0.1%, and this comfortably beat expectations of 0.4%.

The effect of this report is to take US Advance Retail Sales back up to their level in September, and if December can deliver a positive report then official retail sales data will finish 2012 at a record high.

Employment data is always an influential force on financial markets but following yesterday's decision to formally link FOMC policy to a specific unemployment rate target we would expect to see even more attention paid to the various data releases that estimate employment.

We have always found the weekly Initial Claims data to be helpful, since although it is erratic its weekly release schedule means that the deviations from trend are generally ironed out reasonably quickly. Of course Initial Claims can deviate from Non Farm Payroll and the Unemployment Rate for considerable periods (each has its own unique methodology and sample set) but over the course of the cycle there is a close relationship between these three measures, with Initial Claims data generally leading the way.

This morning's print of 343K claims should therefore give the FOMC pause for thought, being the 2nd lowest reading since February 2008. The NSA reading for this week was 428.8K, which is the lowest reading for this week since 2007 when Claims were 423K. Of course it is possible that this week is simply an overshoot to the downside, and will be followed by a sharp revision higher next week, but there is also the possibility that with the effects of Superstorm Sandy in the history books the strong improvement in Claims data that took place in the late summer and early fall is following through into the winter months. The 4 week ma of Claims (see chart) remains elevated at 381.5K, but this measure still contains 2 storm-affected weeks, and can be expected to fall back quite sharply by the time the final Claims report of the year is published on December 27th.

As we have argued in this morning's Weekly commentary, the decision of the FOMC to formally link monetary policy to unemployment data may prove to be a much more hawkish policy shift than either the Committee intended or most participants realize.

Link to text: http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm

Just because something is expected does not mean that it is not remarkable, and the blithe nature with which the FOMC has ushered in two change to monetary policy should not hide the radical nature of these changes. We assume that the FOMC waited until after the election to alter policy, since although the FOMC is nominally independent it is also politically sensitive.

December's meeting has had two substantive outcomes, firstly the FOMC elected to extend asset purchases after the expiration of Operation Twist. Starting in January what had originally been a program of maturity extension designed to lower long term treasury rates has now morphed into additional quantitative easing. The FRB will now purchase an additional $45 bln of long dated Treasury securities but will now longer sell short dated paper to sterilize these flows. This will come on top of the $40 bln of MBS purchases, meaning that the FRB's balance sheet will now grow at $85 bln a month, which would be an annualized rate of 35% based on the current size of the balance sheet.

This is despite the fact that since Chairman Bernanke's Jackson Hole speech last August overall economic data has been robust, including the key employment metrics. Most obviously the unemployment rate, which has clearly been elevated into the uber-statistic of the current monetary cycle, has fallen from 8.3% (using July's data) to 7.7% since this speech was made. Today's statement covered this issue commenting that "..although the unemployment rate has declined somewhat since the summer, it remains elevated". No sense of surprise regarding this development has been injected into the statement, although it is clear from prior minutes the drop was certainly not anticipated.

This brings us to the second and arguably more radical shift in policy. Rather than issue guidance based on a date for anticipated change in policy the FOMC has started to tie policy explicitly to an unemployment rate, with inflation concerns coming in as a distant second, stating that current policy will remain in place:

".. at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored."

Some wiggle room was then allowed for with the comment that:

".. the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When
the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and
inflation of 2 percent."

However, in our experience the market will pay much more attention to the first of these paragraphs, with asset prices now being very sensitive to the monthly unemployment rate, despite the fact that this is one of the least reliable metrics in the monthly data calendar. Moreover our belief is that unemployment may continue to surprise observers by trending lower for the remainder of the favorable data season (which will continue until March). Although it seems highly unlikely that the magical 6½% could be reached by then we could find ourselves close enough to 7% that the bond market starts to twitch nervously that the 2015 guesstimate for the expiry of current policy may unpleasantly inaccurate. As the attached long term chart makes clear, the relationship between the FDTR, unemployment and CPI is complicated to say the least, with the additional complication for investors of understanding how this plays out for longer term yields.

In the meantime the continued bloating of the FRB's balance sheet is really a signal to investors that the FRB is determined to force a recovery at all costs. Although the FRB is injecting substantial capital into long dated treasury and mortgage bonds we assume that the success of this policy will ultimately come at the expense of the bond market. In particular longer dated yields really should start to move higher as private capital starts to get the message that the FOMC is prepared to rewrite the rules as many times as it takes to win the game.

We note that that Swiss Market Index (SMI) succeeded in breaking out to a new 4 year high this morning, following in the footsteps of the DAX index and briefly breaching the 7,000 level (the index was created in June 1998 with a base level of 1500).

This morning also saw the publication of the ZEW survey for Switzerland, a survey of "financial market experts" which is compiled with the help of Credit Suisse. As with the German poll the monthly level is the sum of positive and negative responses with a theoretical range of +100 to -100. In its 6 year history the index has ranged from a peak of +65 (October 2009) and a low of -91.1 (October 2008).

Although Switzerland is outside the Eurozone and actually benefited from massive flight capital inflows which have pushed local interest rates into negative territory, the ZEW survey shows that economic confidence collapses to as low as -75 in September 2011 and -72 in December, just as the LTRO rescue mechanism geared up for action. Since that time there has been a reasonable recovery in confidence, which briefly turned positive in April, before falling back sharply to -43.4 in June as the "mini-crisis" in Spanish sovereign credit took hold.

Recent months have seen another modest improvement in sentiment which has now reached -15.5 in December's reading. Given the volatility of the survey we would treat this as being a roughly neutral reading, which in itself is unremarkable but is an unusual combination with a local equity market breaking out to new highs (even allowing for the multi-national nature of the SMI). As with Germany we view this divergence as being in favor of the local equity market, which we belive can continue to make progress into the early months of 2013.

India's Industrial Production data showed a surprising sharp increase in October, with the Official Index rising 8.2% above October 2011's level, beating expectations of a 5.1% increase. However, this data comes with a number of caveats attached. Firstly October 2011 was an extremely weak month for the index which exaggerates the strength of the rebound. Manufacturing (which has a 75.5% weighting) was the strongest portion of the survey, bouncing 9.1% from a depressed 2011 level while Mining (14.2% weighting) slipped slightly by 0.1% and Electricity (10.3% weighting) production grew 5.5%. Motor Car production was a standout for Manufacturing, with a rise of 25.9% YoY, but again this is really a reflection of weak October activity. As we highlighted earlier this week Indian car sales have stalled this year and there is no reason to expect the manufacturing of cars to accelerate going forwards.

Even including October's data Industrial Production growth for the first 7 months of the 2012/13 fiscal year is a mere 1.2% above activity in the 2011/12 period, and it will take several more months like October to raise the growth rate significantly above last year's tepid pace. It may be that October marks an inflection point for Indian industrial activity, and it may be that this will prove to simply be another data blip. We happen to favor the latter while the local equity market has already priced in the former. The greatest danger is that the local central bank reacts to the better data, and stubbornly high CPI rate (9.90% in November according to this morning's release) by refusing to ease monetary conditions any further.

The Job Opening and Labor Turnover index (JOLTS) is a relatively recent metric, with data starting in December 2000, meaning that it has 2 cycles of data in its history, rather less than most official data. It is not a particularly influential data-set, but it does have the virtue of moving cyclically and once the "noisy" monthly fluctuations are ironed out it tends to give a clear trend signal of the direction in employment openings.

October's data showed total openings of 3675K, up 3.61% from September's reading of 3547 and reversing the dip recorded in that month. This keeps the trend of improvement intact, with October's data being 267K (7.83%) above that of October 2011 and taking the trailing 12 month ma up to 3574K, the highest level since December 2008 and almost exactly the same as the level seen in December 2004. It should be recalled that 8 years ago the notion that the US was in a sustained recovery was still widely contested although the FOMC had started to cause the FDTR to creep higher from the emergency rate of 1.00% in a series of 25 bp moves started in June 2004. By mid 2005 there was no argument about the strength of the economy, although ironically the housing market was about to make its cyclical peak.

Of course unemployment was far lower in December 2004 at 5.40%, making the level of the JOLT perhaps less of an issue back then (to the extent anyone bothered looking at it), but the direction and speed of repair are to our eyes more significant measures of future economic activity than the level of unemployment, which really tells you how damaging the recession of 2007/9 was for the economy, rather than how strong the recovery is today.

China's November monetary data, which followed the release of credit data, makes it clear that it is credit creation and not the provision of new liquidity that has been behind any improvement in local activity. Chinese M1 did grow by 1.22% in November, but this is seasonally a very strong month for liquidity growth (M1 grew by 1.76%, 2.41% and 2.38% in the last 3 Novembers) and so the annual growth rate actually fell back to 5.5%, well below expectations for 6.2%.

M2 grew by 0.90%, which again is below recent November growth (1.01%, 1.51% and 1.36% being the last 3 years data), and this trimmed annual growth down to 13.9%.

Of these two measures we continue to favor M1 as a more accurate reflection of any genuine change of domestic liquidity. The gap between M1 and M2 growth continues to be wide at -8.40% and there is no historic precedent for a gap of this size remaining in place for several quarters (see chart). Almost 9 months into the stimulus of China's economy growth of M1 remains anemic. At 5.50% it is not only below official GDP growth but a fraction of the speed at which domestic credit has been growing in recent months, underlining the substantial difference between the Chinese economy of today and that of three years ago.

November saw a marked slowdown in credit creation in China with both new CNY loans and the wider aggregate known as "Social Financing" falling below expectations. Total CNY loans issued were 522 bln CNY, up from October's 505 bln CNY but below expectations for 550 bln CNY of new loans.

This in itself would have been less surprising if it were not part of a drop in broader credit creation. Total Social Financing fell to 1140 bln CNY, the lowest level since April 2012. This represents a drop of -150 bln CNY from October, but keeps total credit creation 181 bln CNY (18%) above the level of November 2011. We note that corporate bond issuance dropped sharply to 181 bln from 299 bln in October, while Trust loans took up some of the slack by rising 55 bln to 199 bln.

Even allowing for November's slowdown, strength in prior months means that the trailing 12 month ma of Social Financing reached a new record of 1285 bln CNY (approximately $200 bln), up from 493 bln CNY 5 years ago. This is a fair reflection of how much more dependent on credit creation the Chinese economy has become over this period. At an annual pace of $2.4 trln, Chinese social financing compares to peak US credit creation of around the same level in 2005 (using home mortgage, bank credit and corporate bond issuance to define US credit), in what was at the time an economy roughly twice the size of China's current economy. Although it is impossible to directly compare these sums it is fair to say that both episodes saw credit creation become paramount to the level of economic activity.

With the PBOC's balance sheet on hold and exports barely fueling FX reserve growth, the danger for China is that liquidity creation has been lagging credit growth considerably in recent months, as we will discuss in a further note on China's November monetary data.

In our experience all great bull markets end at the point in which issuance overwhelms demand. This always takes much longer than a reasonable observer would imagine, and involves a substantial widening of instruments deemed eligible for issuance as well as increasingly generous terms.

Thus corporations issuing equity in 1999 had no need for earnings or even (in several cases) revenue, while in the great bond issuing frenzy of today credit risk would appear to have become a quaint notion even in the case of sectors and countries who have a history of disappointing bond holders as boom turns to bust.

Attached is a chart which updates US corporate bond issuance YTD for 2012, which has now reached $1.492 trln and would seem likely to finish the year well above $1.5 trln, close to 10% of US GDP (currently estimated to be $15.8 trln). As for the scope of issuance we cannot help but comment on the news that the Metropolitan Opera intends to step into the bond market for the first time in its history. One may argue about the position of opera in a nation's culture (personally we enjoy it in moderation, at least for the first act or two) but its position as a deliverer of reliable coupons has probably never been a subject of debate. The sporting cliche may claim that "it ain't over until the fat lady sings", but perhaps the moment at which she passes a prospectus around is close enough to end to head to the exit and beat the crowd to the bar.

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

Metropolitan Opera Plans $100 Million Debt Offer to Repay Loans
2012-12-10 19:04:34.986 GMT


By Michelle Kaske
Dec. 10 (Bloomberg) -- New York City’s Metropolitan Opera
Association, the largest U.S. performing arts organization,
plans to sell $100 million of taxable debt to end a swap
agreement and repay loans from Bank of America Merrill Lynch.
The group, founded in 1883, is selling debt for the first
time, said Eric Wild, a managing director in the public finance
group at New York-based Morgan Stanley, which is managing the
sale.
Lee Abrahamian, a Met spokeswoman, referred questions about
the sale to Morgan Stanley.
Proceeds will pay down two Bank of America loans totaling
about $63.2 million and end an interest-rate swap agreement with
the bank, according to bond documents. Terminating the swap
cost $2.6 million as of July 31, according to the offering
statement.
The funds will also pay operating expenses, according to
bond documents. The bonds, set to be sold as soon as Dec. 13,
will be sold as taxable securities in the corporate market
because of that use, Wild said.
Moody’s Investors Service rates the sale A3, its seventh-
highest grade. Standard & Poor’s rates the debt one level higher
at A.
The Met is one of the largest opera houses in the world,
with more than 200 performances a season. With a 2013 operating
budget of $329 million, it has 1,600 full-time and seasonal
employees, plus 1,800 part-time workers, according to the bond
documents.

For Related News and Information:
Top Stories: TOP <GO>
State Fundamentals: MIFA <GO>
Issuer search: SMUN <GO>

--Editors: Mark Tannenbaum, Alan Goldstein

To contact the reporter on this story:
Michelle Kaske in New York at +1-212-617-2626 or
[email protected]

To contact the editor responsible for this story:
Stephen Merelman at +1-212-617-3762 or
[email protected]

With the classic timing of a pantomime villain, Silvio Berlusconi has once more cast his shadow over Italian politics and by extension its capital markets. We view this disturbance as an understandable attempt to position Berlusconi and his party as favorably as possible in the run up to the inevitable election of early 2013. Italy's 10 year note yield pushed 28 bp higher this morning, reaching 4.81%, its highest level since November 21st, while the local FTSEMIB index fell 2.77%.

While we understand the market's distaste with this particular politician, it is not clear that anything significant has changed for the worst. Challenges from the right (and the left) are to be expected at the current time. However, if premier Monti is successful in passing his budget and then finds himself (or an ally) elected by popular vote one would argue that Italy has made significant progress towards a stable footing. No doubt this will be a noisy and nervy process, but the odds still remain that Italy's capital will remain in an improving trend in the weeks ahead, although in the short term turbulence may continue to be considerable.

Indian car sales have grown considerably less than had been anticipated in recent months. SIAM, the local trade group had originally forecast a 9% growth rate for the April 2012 - March 2013 sales period, a forecast which was slashed in October to virtually nothing. November's data is starting to make this amended forecast look optimistic with sales falling -8.25% from November 2011 to 158K, a level which is also below that of November 2010 (160K). We note that the 12 month ma has stalled at 169K and we would expect this metric to start to fall lower in the coming months. It should be noted that Indian car sales enjoyed explosive growth between 2009-2011, growing approximately 60% over this period as loose monetary policy boosted what is always a credit sensitive area of an economy.

Until recently, two-wheeler (motorcycles and scooters) sales had held up well, but again signs of stalling demand are now visible in the data. November's sales were 1.329mm, almost exactly flat with November 2011. Again we note that the trailing 12 month ma has flattened out at 1.30 mm units, up from approximately 700K in 2009. With the RBI likely to remain hawkish in its monetary stance, we would expect both car and two-wheeler sales to continue to come under pressure in the months ahead.

Although Chinese domestic economic data continues to hold up well it trade data paints a much more problematic picture with both imports and exports slowing dramatically in recent quarters.

November's data showed no improvement to this trend with imports flat on a YoY basis and exports growing at a mere 2.9%. Moreover the export data is increasingly reliant on exports to Hong Kong, which grew by an anomalous 35.2% YoY and is now the top Chinese export market at $33.32 bln, beating the US into second place at $30.13 bln. Clearly most of these exports are then shipped out of Hong Kong to other markets, but we fail to see a similar surge in Hong Kong export data (it should be noted that the two data series are not strictly comparable). This does therefore bring up the question as to whether Chinese exports are in fact already declining YoY.

As for imports, it is very hard to reconcile flat growth with the sort of strong economic growth reported in earlier in November's Fixed Asset and Industrial Production. In this discrepancy we favor the trade data simply because it is allowed to fluctuate, while the "big picture" economic data seems to never stray too far from the party line. The message for trade data is that this portion of China's economy has essentially ground to a halt, which is somewhat out of line with the much more optimistic assumptions baked into most observers' expectations for China's economic performance.

We also continue to track China's imports from its fellow BRIC countries, where a marked slowdown in activity can be seen to have taken place in recent months. Imports from Brazil (green) has seen exports to China slip -30.5% YoY, with November's $3.51 bln being the lowest level of imports since April 2011. Russian exports to China have fallen -8.2% much less, than Brazil's and were $3.38 bln. As for India although November saw a small MoM increase to $1.12 bln from $0.98 bln, this still represents a massive 43.7% decline from November 2011's level.

Those looking to Chinese data for signs of the much relied upon "soft landing" will take heart from November's "big picture" economic data, which showed a modest rebound in Industrial Production and Retail Sales and a modest deceleration in Fixed Asset Investment.

Industrial Production was estimated at 10.1%, above the consensus rate of 9.8%. YTD Industrial Production was in line with estimations of 10.0%, which would put China's Industrial sector expansion far above any other large emerging or developed market economy. According to the data, production of rolled steel was the greatest contributor to growth (16.5%) approximately twice the pace of car production (8.1%) and 4 times that of all motor vehicles (3.9%), which would make for an unusual mix of industry if sustained over the longer term.

Retail sales were estimated at 14.9%, above estimates for 14.6% growth. We will be interested to see if this improvement is reflected in retail sales announced by western companies doing business in China in the January earnings season. We do note that November's car sales (which it should be remembered are WHOLESALE not RETAIL numbers) showed a decent pickup in activity from the depressed sales seen earlier in the year.

Fixed Asset investment growth was flat at 20.7%, missing estimates of 20.9%, a fact which will not trouble those taking a sunny view of China's prospects. As encouraging as this report may be to some observers, the key is whether this statistical improvement actually translates into a better environment for public companies doing business in China, since without confirmation from actual sales of industrial or retail equipment we would be unmoved in our assessment that the Chinese economy continues to experience a marked deterioration. We also have a hard time reconciling the stability of China's "internal" data with the marked deterioration seen in its trade data (see today's note on Chinese trade).

The US Consumer Credit data (released late last week) shows a persistent re-leveraging by the US consumer and although the vast majority of this credit creation is in the non-revolving portion of credit (which is dominated by student loans and automobile loans) there are signs that revolving credit is starting to grow also.

November's data showed total consumer credit grew by $14.16 bln (0.52%), which is the 33rd time credit outstanding has risen over the last 36 months. Outstanding credit reached a new all time high of $2,753 bln in October, compared to its prior cycle peak of $2,583 in July 2008. Non-revolving credit grew by $10.7 bln (0.57%) to reach a new record of $1,895 bln. Clearly to the extent this number has been bloated by student loans we would view this as being largely outside the world of discretionary consumer expenditure, but we would assume that a rapid increase in auto-related credit has taken place in recent months.

As for revolving credit, this grew by $3.6 bln to $857 bln, which keeps the annual growth rate at just over 1%. Current credit outstanding is still about 16.5% below the peak of the prior cycle, and it is here that the greatest de-leveraging by US consumers has taken place as a proportion of debt outstanding (mortgage credit has fallen by a little more than 10% by comparison, although the aggregate sums involved are about 10 times those of revolving consumer loans). We appear to have reached the point at which revolving credit has stabilized and will start to become more prevalent as consumer activity continues to grow, with credit granting becoming an increasingly important factor in future activity.

We have always maintained that it is much more important to track what a central bank actually does rather than what they say they are going to do, a point well proven in 2011 when the ECB's balance sheet suddenly started to silently expand in August 2011.

At present we have the opposite issue with the FRB, which announced an intention to purchase $40 bln of MBS a month in September but is yet to significantly increase its published holdings of these securities. FRB MBS holdings were $856 bln in mid September and were announced to be $884 bln last night (as of December 5th). Over this period the overall FRB balance sheet has increased from $2.807 trln on September 19th to $2.843 trln today. This compares to a level of $2.798 trln a year ago, which essentially means no quantitative easing has taken place over this period (although the FRB has extended its maturity through Operation Twist over this period).

We do not have a good answer for the the gap between the announced policy intention and its execution. We have seen some analysis which points to a lag in settling purchases that may already have been made and although this is a possible explanation we note that this lag did not take place in 2009 when "QE1" saw the FRB first expand its MBS holdings aggressively. We would therefore conclude that up until today the FRB has been rather less help than the market may have anticipated, and we will continue to monitor the balance sheet going forwards to see if this changes in the weeks ahead.

As we noted yesterday the local expectation for the direction of the SELIC has started to shift substantially in favor of further rate cuts in the coming months, a view which we have endorsed for several months.

This morning saw the publication of November CPI data, which showed an increase of 0.60% for the month and 5.53% for the year. This was slightly worse than expected, and keeps CPI on its modestly positive path since bottoming at 4.92% in June. This therefore marks the first time that Brazil's interest rates have continued to fall during a period of rising inflation, which again emphasizes the fairly radical change in monetary policy that has been wrought in recent months.

At present the SELIC is 1.72% above local CPI, the tightest spread seen since the rate was established in 1999. We would expect this spread to continue to tighten, and it is possible that we will even see a negative "real SELIC" at some point this cycle. We would stress that the primary cause would be a lowering of rates rather than a surge in Brazil's CPI. Although we expect the latter to remain relatively high compared to other economies we do not expect it to surge much higher in the coming months. Therefore although some have argued that CPI poses a threat to the move towards a lower rate environment we ourselves doubt that this will prove to be the case, provided we do not see an explosion of CPI to the upside (which we currently do not foresee).

We continue to use the experience of the US in the late 1980's as our guide for Brazil in the current cycle and it should be recalled that between September 1992 and June 1993 the FDTR (which bottomed at 3.00%) was below the CPI rate (apart from in December 1992). This was seen a "monetary heresy" at the time, as would be the case in Brazil this cycle, but as we have seen time and again when the going gets tough, the monetary and fiscal rules get rewritten.

Thinking logically one would have expected to see a significant impact on November's BLS employment report from the recent storm (Initial Claims data certainly showed a sharp but temporary impact), but logic is rarely an asset when predicting this quixotic report.

In the event November's headline number showed an increase of 146K jobs, well above expectations of 85K. To some extent this was dented by a sharp revision lower of October's report from 171K to 138K. On the other hand the Private Sector report showed a modest revision HIGHER for October of 5K to 189K, while the November report came in at 147K, well above expectations of 90K. This keeps the 12 month ma of Private Sector gains (our favored manner of using this data) rooted at 160K, suggesting that despite the volatility of the data in recent months, very little change to the pace of progress has actually taken place in either direction.

Meanwhile although the Household survey showed a drop of -122K jobs (perhaps indicating a greater sensitivity to the storm's impact thanks to the fact that it is based on interviews with individuals rather than a business survey), its 12 month ma continues to be somewhat stronger at 220K, and to suggest that a material improvement in hiring has taken place since 2011 (the 12 month ma was 139K last November).

This discrepancy is important since it is the Household survey which is used to "calculate" the all important unemployment rate. This fell in November to 7.7%, its lowest level since December 2008. As we have pointed out several times in recent months, unemployment data tends to have great momentum behind it and once it starts to move in one direction or another it tends to do so with a power and persistence that surprises observers. In this regard it should be noted that the FRB had no idea that unemployment would start to fall sharply in July when it was 8.30%, and it is this figure which informed Chairman Bernanke's speech at the Jackson Hole summit that provided the intellectual argument for QE3.

This brings up an interesting point. It is notable that it is the more dovish members of the FOMC who have been pushing for an explicit link between monetary policy and the unemployment rate (which they believe to be at risk of staying very high for a prolonged period of time). It would be ironic if they were successful in changing the framework for policy only to find that unemployment was falling substantially faster than they had anticipated, causing interest rates to start moving higher on an expedited basis. This is not a risk at current levels of unemployment (the 7.7% rate is roughly the peak of unemployment in the 1990/92 recession) but if the rate were to continue to fall sharply in the winter months interest rates could find themselves with something of a spring in their step.

For the second consecutive month the SNB announced a drop in FX reserves, which fell in November by 2 bln CHF (-0.47%) to 425 bln CHF. The size of the drop is modest, and reserves are still 193 bln CHF (83%) higher than they were a year ago but the fact that the SNB apparently no longer has to intervene on a continuous basis to keep the EUR/CHF cross above 1.20 is itself a significant development. This suggests that the panicky flight out of € denominated deposits has really ceased in recent weeks, and perhaps been replaced by a trickle of funds heading in the opposite direction.

This reversal process received a boost at the start of December with the announcement from Credit Suisse that CHF deposits will start to be charged a "negative interest rate". This had an immediate (if modest) effect on the EUR/CHF, bringing the rate as high as 1.217 before it slid back down to 1.208 this morning. We would expect to see other Swiss banks follow the same path, which should allow the SNB to slowly unwind some of the massive excess reserves it built during the Euro-crisis. Unfortunately this pace of unwind is likely to be far too slow as far as the excess of local liquidity is concerned, with the danger of a local asset bubble remaining one of the key challenges for the SNB in the coming quarters.

When we suggested last summer that Brazil's SELIC would fall below 7.00% in 2013 this was a heretical view, with most observers expecting to see rate increases come into play by the middle of 2013 rather than a series of cuts. Indeed 3 months ago the curve for Brazil's overnight deposit rate (ODA Comdty) priced in an increase of about 50 bp over the course of 2013, and this remained true until the release of further poor economic data over the last couple of weeks. In recent days the curve has suddenly switched to allow for modest rate cuts and we note this morning that two influential local banks slashed their 2013 SELIC predictions from 7.25% to 6.25%.

In addition to poor data, there has come the realization that the current administration is determined to "stimulate" the local economy at all costs. One of these costs looks certain to be the independence of the central bank which will increasingly be expected to do the governments bidding, either voluntarily or under duress. This will include both interest rate and currency management. Both can be expected to lean towards loosening, with any further deterioration of data bringing more radical action.

Although in the end as a result of these moves conditions in Brazil should become quite favorable (provided that government intervention in local industry does not continue to expand aggressively) this process will take a substantial amount of time (a number of quarters), during which worsening local economic and corporate news will continue to place asset prices under pressure. The shift in the prediction of interest rates is an important milestone in this process, that suggests that local participants are starting to grasp the magnitude of the issues they are facing.

After suffering a "statistical recession" earlier this year most of the data coming out of the UK suggests that a reasonable recovery is underway, with consumer activity generally better than most observers had expected. UK New Car sales are a good example of this phenomenon, and these posted another strong month in November, rising 11.3% on a YoY basis.

This takes the trailing 12 month ma of this measure up to 4.28% (this is a fairer measure given the substantial seasonality of monthly sales), which while not exciting is well above zero growth. The example of the UK as a country that has undergone at least a fair degree of austerity is instructive, since although growth has been disappointing it is not clearly in worse shape than other economies who have cleaved to a more expansionist role for fiscal policy. The direct effect of "stimulus" and taxation on economic activity is generally much smaller than most people understand, and this should be kept in mind given the current manic obsession with the threatened expiration of the Bush tax cuts in the United States.

The effect of Superstorm Sandy would appear to have blown out of US employment data as quickly as it appeared, with this week's Initial Claims falling back down to 370K, in line with the levels seen in the October pre-storm data. This data took the 4 week ma up to 408K, but it seems clear that this metric will now start to fall sharply going forwards. Indeed should next week's report prove to be unchanged the 4 week ma would fall by over 20K, as the very high November 9th print of 451K falls out of the calculation of the average next week.

How all of this affects tomorrow's BLS report is anyone's guess. However, one could argue that there is only upside in tomorrow's report, since weak data is likely to be blamed on the storm rather than the underlying economy. In this regard the bar has been set relatively low at 86K for Total and 90K for Private Sector job gains.

The ISM Non-Manufacturing Index continues to demonstrate steady growth in the US service sector with the index rising slightly to 54.7, and thus beating expectations for a 53.5 reading.

We note that the Business Activity sub-index was particularly strong at 61.2, which is the strongest level seen since February 2011 and New Orders were also very solid at 58.2, the highest reading since last March. Employment was less positive, falling to 50.3, its lowest reading since July, but we note that this sub-index has been fairly volatile. In general a strong order book and level of production can be treated as leading indicators and although we do not treat this data series as being of great predictive value it is a generally encouraging report.

One of the most common misconceptions about economic cycles is that consumer activity only starts to strengthen once unemployment has fallen sharply. Instead the real inflection point tends to come within a few months of the peak of unemployment in a cycle. This is because for those who maintain their jobs the key variable is their belief that they are likely to remain employed, and once unemployment peaks and starts to move lower then this confidence amongst the employed majority starts to build fairly rapidly, leading to a recovery in actual activity if not necessarily confidence polls (this has certainly been the case in the US since the summer of 2009).

It is therefore important to note that Ireland would seem to have reached this inflection point, with the Live Register of unemployed persons falling steadily since peaking in the summer of 2011. November saw a fall of -1.5K, the 5th consecutive fall and the 9th decline over the last year. The Register has fallen by 13.60K over the last 12 months to 432.50K, which is the largest annual decline since February 2005 when the overall Register was much smaller at 156.50K.

With an unemployment rate of 14.60% Ireland clearly still has a great deal of hardship in its local economy, but we are increasingly optimistic that the nascent recovery should be able to pick up pace in the months ahead.

There is finally some signs of life in the MBA Purchase Index, which tracks weekly applications for mortgage loans used for buying a home. Unlike refinancing activity (which has been booming since the springtime) purchase mortgage activity has remained extremely muted since 2010, with the index falling as low as 157.9 in August 2011, compared to peak activity of 529.30 in June 2005. In recent weeks the index has pushed above the 200 level and managed to stay there, and we note that this week's reading of 206.50 marks the first time the index has been above its trailing 200 week ma since February 2008. We would not call the current move decisive yet, but if the index can continue to build momentum and register readings above 225 then we would be quite confident that something meaningful is taking place.

It is notable that during the last 30 months a steady increase in the pace of the existing home market has been in evidence with activity rising from less than 60% of normal to around 80% of normal since July 2010 (see yesterday's note). It would appear that the vast majority of this increased activity has been created by investor funds, which did not rely on increased mortgage granting by lenders. It has therefore been possible to create a healthy resale market without an acceleration of home lending, although clearly more lending would be beneficial to the market. It would also be an indication that the US banking system is finally starting to embrace the recovery in the local housing market.

The New Home market on the other hand has been much more sluggish over this period, and it is important to note that this market is almost entirely reliant on mortgage lending. We would therefore expect to see New Home sales activity correlate quite closely with any breakout by the MBA Purchase index.

The ADP Employment report for November estimated job additions of 118K for the month, in line with expectations of 125K. October's report was nudged lower by 1K to 157K. As we commented last month the change to the methodology of this report now makes it a much less useful counterbalance to the official BLS report but given the negative impact of the storm in early to mid November this is a reasonable report, albeit one that will have very limited market impact. Friday's NFP report will set the tenor for the market, and here consensus is looking for 87K of Total and 93K of Private Sector gains. This is a fairly undemanding target but the volatility of this data together with the genuine impact from the storm means that nothing can be taken for granted.

We continue to monitor Japan in an attempt to discern whether a material positive change in the local investment environment has taken place, or if the Nikkei is simply enjoying another brief respite in its generational bear market.

One of our most important guides in this respect is the change to the monetary base, since arguably Japan has radically underperformed since the mistaken decision to shrink local money supply in early 2006.

With the exception of a brief period following the natural disasters of 2011 the BOJ has operated a tight policy from the point of view of liquidity supply (the price of liquidity is something else entirely) since 2006. This summer seemed to mark a change, the the local monetary base growing by as much as 10.8% YoY. November's data showed a marked deceleration with the seasonally adjusted base actually shrinking by a little more than 1% for the month, trimming the annual increase to 5.0%. If November is simply a blip that is followed by a more robust pace of increase in future months this would not matter (the data does swing quite violently on a month to month basis), but if the pace of expansion were to slip back into low single digits there really would be little reason to expect for substantially better news from Japan going forwards.

The publication of the November New Car data gives us an excuse to revisit an old chart, which compares activity in the US New Car, Existing Home and New Home markets.

In a normal economic cycle there is a close relationship between activity in these three markets. It is certainly true that the 1980s boom was perhaps more about general consumer activity than housing (car sales rose even faster than home sales) and the reverse was true of the 2002/7 period, in which car sales remained normal while home sales rose to an unsustainable level before starting to crash at the end of that period. From late 2007 onwards, severe pressure on activity was visible in all three markets, followed by an abrupt crash in the late summer of 2008.

The damage wrought in this crash was uneven. New car sales fell to approximately 50% of normal (using December 2002 activity as a yardstick) in February 2009 but almost immediately began to recover from this level, even if one ignores the mini-boom and bust of "cash for clunkers", and following November's release have reached 87.7% of "normal" activity . The existing home market took somewhat longer to bottom, hitting a low of 56% of December 2002 activity in July 2010. Ironically one reason for the delayed bottoming was the distortion caused by tax credits, which artificially shifted demand into late 2009 and Spring 2010 purchases. Since bottoming, a fairly rapid recovery in activity has taken place with our index reaching 79.9% in October.

The New Home market is the real outlier. Having reached a peak of 132% in July 2005, the index collapsed to 26% in February 2011. Although a decent recovery in home sales in terms of percentage growth has taken place, since then the low base means that home sales are still only 35% of "normal" activity. We do suspect that the Census Bureau data underestimates current activity, but even so we doubt that a more accurate reading would be much above 40%, which would still represent activity of around half the pace of Existing Home and New Car sales when rebased against December 2002 activity.

It is our belief that as the two stronger markets approach normal activity levels, a much stronger pace of recovery should start to become apparent in the New Home market. Although perhaps the homebuilding sector itself allows for such an outcome, general expectations of the US economy have not factored in the potential impact from a "normalizing" of activity in New Home sales and construction. This is particularly true of the Federal Reserve, which seems to believe that the current state of affairs is semi-permanent and has shown no sign in meeting minutes of allowing for the possibility of a housing led impulse taking the economy well above its growth projections in 2013.

Although the impact of Superstorm Sandy on economic data is generally negative over the short term, one area that did get a boost was new car sales, with a substantial number of additional vehicles purchased as replacement for cars rendered useless by the storm.

This storm related demand served to accelerate what was an already a strong recovery trend in vehicle sales, allowing total November sales to reach 15.46 mm units (SAAR), which is the best level of sales since February 2008. This is 1.96mm units (14.5%) above the pace of November 2011 and takes the trailing 12 month ma up to 14.27mm units, which is the highest it has been since September 2008. It seems increasingly likely that 2013 will be the first "normal" year for new car sales since 2007, which underlines the degree to which the US consumer has been a vital force in the current economic cycle.

The attached article describes the decision of Credit Suisse to start charging interest on cash holdings denominated in CHF. This step has been a logical possibility for months but it is still interesting to see a large institution take the decision. We would expect others to follow, and would not rule out this practice spreading to other currencies (German bank cash balances would be an obvious possibility), if Credit Suisse is successful in passing on this cost to customers.

Commenting on US economic data in the aftermath of Superstorm Sandy is going to be a little harder than usual, and we suspect that at least part of the weakness in the November ISM report can be traced to the storm's impact.

The overall index came in at 49.5, the weakest reading since 2009 (but only just below the level of August 2012). This is the 4th sub-50 reading since May, suggesting that manufacturing activity has been roughly flat over that period of time. However, unlike the summer weakness the problem in October seems to be connected to a sharp Inventory draw-down rather than weakness in New Orders or Production.

Inventories (olive) fell to 45, the lowest level since June, while Customer Inventories fell even more sharply at 42.5. New Orders (red) on the other hand were flat at 50.3 while Production (blue) continued to grow at 53.7, the strongest data since May. Employment (pink) was probably the weakest report, falling to 48.4, which was the lowest reading since late 1999. The sub index data therefore suggests that lower Order growth was more a reflection of Inventory management than a lack of end demand (which would be a logical impact of storm related disruption). We therefore are not too concerned by the overall report, and would be hopeful that December sees a move back above the 50 level for the overall index.

In choosing the subject matter of our regular pieces, we try and keep an eye on what is changing, rather than simply report good or bad economic data that is widely expected. Thus we will refrain from commenting on the myriad of PMI reports, which fairly straightforwardly revealed Europe's manufacturing to be under modest contraction pressure while most emerging markets were neutral to modestly positive (we are genuinely unsure as to the value of these reports, whose number has exploded since the 2008/9 crisis).

Much more interesting was a very poor set of trade data out of Indonesia for October. Indonesia's Trade Balance was estimated to be -$1547mm, far worse than expectations for a $466mm surplus. The cause of the shortfall was primarily a large drop in exports, which fell to $15,557mm, a drop of -7.61% from October 2011 while Imports remained very strong, rising 10.82% to $17,214mm. Although it is possible that this month's data overstates the deterioration, the trend in recent months has been for a substantial reduction in surplus and the trailing 12 month ma has fallen rapidly back towards zero.

It would appear that sharply lower prices for both palm oil (see chart) and coal have started to eat away at Indonesia's trade position, while the domestic economy continues to boom. With local money supply growing at 17.55% (M1) and 18.30% (M2) there is arguably scope for tighter monetary policy, and it will be interesting to see if the local central bank chooses to respond to the worsening trade position in the coming weeks.