In recent months we have noted that a number of large emerging economies have experienced a substantial deterioration in their trade balances (the reverse is true of many European nations). South Africa is no exception to this trend and its January 2013 data showed the largest ever monthly deficit at -24.5 bln ZAR (-$2.7 bln). This is significantly wider than expectations of -$9 bln and compares to a level of -13.5 bln ZAR a year ago.

Over the last 12 months the deficit has averaged -10.55 bln (-$1.17 bln) and is estimated by the National Treasury to average 6.2% over the next three years, a forecast that is starting to look quite optimistic. Although a portion of the deterioration has been caused by the ongoing mining labor dispute, which can be expected to eventually be resolved, other causes would seem to be more intractable.

The yawning deficit has started to put considerable funding pressures on the ZAR, which despite strong investor flows has lost considerable ground over the last year, falling from 7.50 to 9 against the USD. Following the trade report, the currency fell sharply to 9.01 and can be expected to now challenge the January 28th low at 9.16. As the attached long term chart of the ZAR shows this currency has a long history of abrupt devaluation, reaching almost 12 in late 2008 and 14 in late 2001. The current decline has thus far been more sedate, but it should also be considered that foreign investment flows have this time been in favor of the currency during its decline. Should this cease to be the case a rather more rapid descent could be anticipated.

Although its big data pedigree means that this morning's revision to GDP will dominate the headlines, it has little to offer as a guide to future progress. More interesting was the sharp drop in Initial Claims, which indicates that last week's spike was holiday related (as we assumed at the time). This week's report showed estimated claims back down to 344K, well below consensus (360K) and last week's level (366K, revised up from 362K).

This caused the 4 week ma of Claims to fall back to 355K, and we would hope to see some further progress made on this metric during March, when seasonal inputs remain favorable. It remains to be seen what impact this will have on the more senior Non-Farm Payroll report, which has been delayed this month to the second Friday of the month (March 8th), meaning that an unusually large amount of other data regarding February's activity will already have been released by the time the BLS report becomes public.

Short excerpt from the morning's interview. Concentrates on the lack of impact of sequestration on markets.

www.bloomberg.com/video/marketfield-is-long-america-michael-shaoul-says-uib__w7GTQOUQMxRh2yKaA.html

As we have explained in prior notes, the drop off in domestic demand in Spain has spurred something of an export boom in recent months, resulting in 2012 generating the smallest trade deficit since 1998 at just over -€24 bln. This figure is actually more than compensated for by a similar pattern in "invisible" trade in services, which posted an all time surplus of $39.6 bln in 2012, up from €34.2 bln in 2011.

Perhaps most surprisingly December actually saw a strong surplus generated in Spain's Investment account with the positive balance of €0.8 bln being comfortably the highest on record, although for 2012 as a whole a deficit of -€18.36 bln was recorded, compared to -€26.04 in 2011. This had the effect of generating a very strong surplus of €4.88 bln in the total December Current Account, marking the 5th time out of the last 6 months that this has been in positive territory. The cumulative Current Account for 2012 remained negative at -€8.26 bln, but the trailing 12 month ma has a decent chance of pushing into positive territory in early 2013, which would be the first time this has happened since 1997. Given that two years ago the Current Account was showing an annual drain of -€47.4 bln this is a substantial turn around which should have a tangible effect on liquidity going forwards.

The deep-seated economic problems facing the Indian economy are starting to become increasingly obvious to local investors with this morning's budget statement being very poorly received. In announcing steps that are aimed at reducing the current -5.2% deficit to a target of 4.8% in fiscal year 2013/14, the government made clear that the burden will fall squarely on higher taxes for the wealthier segments of the population with a one year 10% surtax on those earning 10mm INR ($185,000) and increased duties on yachts and high end motor vehicles. Meanwhile spending on the poor is scheduled to increase (unsurprisingly given the approaching election) and this will be balanced by cutting subsidies (which runs the risk of causing an inflationary spike) and asset sales (which are one off revenue items that do not address the longer term deficit).

Unsurprisingly this budget has been poorly received with the SENSEX index falling -1.52% to 18.861, meaning it has now fallen -2.91% YTD despite the fact that foreign investors have poured a record $8.45 bln into Indian equities in the first two months of the year (an annualized rate of $50.7 bln). The real damage was wrought in the small cap sector where the BSESMCAP index fell another -1.97% to 6,206. This index has now fallen -15.90% over the last two months and is currently testing support at the June 4th low (6,132). It is our contention that the small cap index is a more accurate reflection of the dissatisfaction of local investors since it receives little of the foreign investors' allocations.

A further blow to the psyche of the market was added by GDP data which was released after the close. This showed estimated growth of 4.5%, well below estimations of 4.9% and last quarter's pace of 5.3%. As can be seen GDP has decelerated markedly in recent quarters and we very much doubt that the populist path taken in the current budget will help matters going forwards.

After dipping sharply last month the NAR's estimation of US Pending Home Sales rose to 105.9 in January (2001 activity = 100), which effectively removes any concern regarding the December data. As can be seen on the attached chart Pending Sales are in a steady trend of improving data, with the trailing 12 month ma now at 101.1 compared to 90.3 a year ago. The NSA data shows the index at 86.3 (January is typically a quiet month for sales), which is the strongest January reading since 2007 and compares to a reading of 78.2 in January 2012.

What makes matters interesting is that a normal level of Pending Sales is now operating in the face a extremely tight inventory. We have attached a chart which calculates the ration of total Existing (Single Family and Condo) and New Home inventory to the level of Pending Sales. As can be seen this ration crossed the 2 level for the first time in its 12 year history in December and January's surge in Pending sales and sharp drop in inventory has caused the ratio to contract further to 1.78. In other words the US housing market is now experiencing a historic degree of tightness going into the key spring selling season. This can be expected to create something of a cap in overall sales activity, but to also lead to a significant degree of house price appreciation, which should in turn both free up inventory (primarily from existing homes currently "under water") and also accelerate construction activity for New Homes.

As may have been expected the market turmoil following the Italian election has caused a marked dip in the Bloomberg Eurozone Financial Conditions Index (BFCIEU), which has fallen to +0.05 this morning, its lowest level in three months. This therefore keeps intact the similarity between the performance of this metric and that of the US equivalent (BFCIUS) in 2010.

A good portion of this decline has been caused by a sharp decline in the EuroStoxx index (S5XE) and the related rise in the VDAX (the German equivalent of the VIX), which has risen to 18.70, its highest level since early September. Strictly speaking this is more an indicator of nervousness than actual financial stress, although clearly one can lead into another. Of more relevance is the sharp bounce in the 10 year swap rate, which has been bouncing between 29 and 32 bp all afternoon, taking the swap rate back to the level of November 2012.

A lot will depend on how things develop from this point on. Conditions remain just above "normal" and even a shallow dip into negative territory would not cause great concern. We are certainly a long way away from the crisis levels seen in 2011, and their echo in early 2012, neither of which look likely to be matched. However, the risk of a correction of the magnitude of 2010 remains quite real unless Eurozone markets can find a stable floor close to current levels.

Brazil's outstanding loans showed almost no growth in January, which is partly due to seasonal factors (January is traditionally a quiet month for credit issuance) and also probably caused by a change to the methodology used to calculate mortgage credit outstanding. This change also means we do not have a full breakdown of the sectors to which credit was granted and it is unclear if this data will be provided going forwards.

Perhaps most annoyingly the central bank has ceased to supply Private Sector bank loan data separately, which makes it much harder to track the radical shift in loan issuance towards Public Sector banks. Whether this is part of a deliberate policy to obfuscate or just an unfortunate outcome of a methodological change is unclear, but the effect is to remove some of the transparency from Brazil's loan data just as we enter a crucial phase of the credit cycle. We have no reason to doubt that State banks have continued to be more aggressive in the market and the flat overall loan data for January suggests that Private Sector banks probably contracted their outstanding loans modestly last month.

Meanwhile the Default rate for Personal loans fell to 7.90% in January, but this is a reflection of the fact that December's Default rate was revised 0.1% higher to 8.0%. This means that last summer's improvement in defaults would appear to have halted. As we noted this morning there is some evidence that Brazil's employment cycle has started to turn negative and should this be the case then the Default rate can be expected to start to move higher, even though Private Sector banks have tightened their underwriting standards in recent months.

It has taken a few months but the official Census Bureau data is finally starting to reflect the very strong rebound in activity that has already been reported by the public homebuilders. Although this does not change the reality of facts on the ground it should provide a useful fillip for sentiment towards this area following the turbulence of recent days.

In terms of the data itself, total January home sales were estimated to be 437K, well above expectations of 380K (indeed the highest estimate was for 409K). Total revisions for prior months were +4K, giving a "net" figure of 441K. January's pace of sales is the highest seen since July 2008, meaning the data has finally overcome the level reached during artificial boost caused by the 2009/10 tax credits, while the YoY gain of 98K is the largest pickup in sales in nominal terms since July 2005. Sales of course remain very depressed in historical terms, and it should be noted that January is seasonally a very weak month for sales which does add to the volatility of the data. Nevertheless the fact that we already have strong data from the public homebuilders means that we have little reason to doubt the ultimate level of January sales, even if the actual surge in activity probably took place over a number of months.

Meanwhile inventory of new homes remained at 150K, although the surge in sales means that this is now only 4.1 months of activity, the lowest ratio since 2005. Observers have become used to the current ultra-low level of New Home inventory since until recently it coincided with a glut of Existing Homes for sale. As we mentioned last week Existing Inventories have also collapsed in recent months and this has caused the total inventory of US Existing and New Homes to fall to 1.70mm homes in January. This is the lowest total seen since the data starts in 1982 (see chart), a quite remarkable statistic that is largely uncommented on.

Clearly we have reached the point at which growing demand for EITHER New or Existing Homes will require an acceleration in building activity. We would also expect to see a faster pace for house price inflation as demand continues to build, at least for the period in which interest rates (Which drives affordability) and inventory remain at their current historically depressed levels, all of which should be good for profitability in the homebuilding and construction material sectors.

The Italian election result has come as something of a disappointment to the market and thanks to the inaccuracy of the initial exit polls we have some idea of how a Bersani victory would have been priced versus the deadlocked parliament that was produced. At it's height the FTSEMIB was up over 3.6% yesterday compared to a decline of -4.35% today, creating a total swing of around 8% over the last 24 hours. The bond market was equally emphatic, with the Italian 10 year yield falling from 4.40% to 4.20% yesterday morning before reversing these gains later in the day and soaring to 4.90% this morning.

Nevertheless this does not mean that Italy's progress has now ground to a halt and that a return to the chaos of 2011 and early 2012 is sure to follow. The election result itself should be seen to be a combination of wholesale rejection of "politics as usual", leading to the unexpectedly strong showing for Beppe Grillo, and a forceful reminder that Italy remains a coalition of regions where local identity matters at least as much as within the US. Hence Berlusconi, the bogey-man of the market was able to ride a regional wave of popularity back to relevance on the national stage, while the pre-election favorite Bersani has found himself in a dog-fight for the right to lead a coalition government.

Although this clearly represents a much less certain environment for markets, it does not inevitably mean that Italy faces a return to crisis conditions. Countries with long traditions of coalition governments are used to the "double-think" between election promises and the messy compromises that follow a result, and 24 hours after the election there are already signs that the horse-trading has begun. Much will depend on how the inexperienced Grillo block ends up operating in practice, but based on the experience of Jesse Ventura's governorship of Minnesota, rather less of a challenge to the working order should be expected than was promised in the election.

As to the markets, the damage wrought yesterday was ugly when viewed with a short term lens but much less so using a longer term frame. We have attached a chart that shows the behavior of the 10 year yield (inverted scale dark green) and the FTSEMIB index (red). In terms of the yield, 4.80% is roughly where things stood in late November before the wave of hot money poured into the market at the end of the year, while the equity market is back to where it was in mid December. Although this might be disappointing to newer investors it is hardly catastrophic, and the equity market in particular now has a band of strong support. We would also note that back in June 2011 a 4.80% 10 year yield co-existed with a 20,000 level in the FTSEMIB, suggesting that the equity market remains unusually depressed at current prices.

The reaction of the Italian corporate bond market should also be considered. This actually rallied in the face of the election result as money fled the sovereign market for the relative safety of large corporate balance sheets, and ENI's 2019 4⅛% note's yield fell from 2.36% to 2.31% (see chart). As we have argued many times before Italy's issues are deep at the fiscal and political level, but less so for the overall corporate sector, which has sustained its activity at a reasonably buoyant level throughout the crisis. The result of the election complicates the narrative but not necessarily the overall investment opportunity over the longer term.

There are finally some signs that the collapse in Brazil's job creation rate (as measured by the CAGED index) is starting to be reflected in unemployment data. As we noted last week although the rate of job creation has halved over the last 12 months Brazil's unemployment rate had registered a series of all time low readings, culminating with a 4.60% rate in December. January saw an unexpectedly large bounce in the unemployment rate to 5.40%, compared to expectations of 5.20% (the data is not seasonally adjusted and tends to trough in December and then rise for the next 3 months).

This large rise still keeps the YoY change at -0.1%, but at the very least suggests that the unemployment rate has marked its cycle low with further improvement quite unlikely. Given the collapse in the CAGED index It is certainly possible that unemployment may even now start to rise, and it will be interesting to see whether the March reading (typically the highest of the year) exceeds that of March 2012 (6.20%) or 2011 (6.50%). Our guess is that it will be somewhere between these two readings, which would be enough to suggest that the unemployment cycle has finally changed direction.

There are finally some signs of impatience amongst global gold ETF holders, with the total ounces of the metal held in global ETFs falling by -1.36mm oz or -1.62% over the course of last week to 82.3 mm oz. This is the largest weekly fall since w/e January 28th 2011 when -1.65mm oz (-2.37%) were redeemed from global ETFs. It is notable that last week's liquidation sparked a fairly abrupt sell off in the metal itself, which fell to a multi-month low of $1,555.55 on Thursday before recovering to close the week at $1,581.40. Even after this reduction in holdings, they remain over 5mm oz greater than they were in late July 2012 when the metal was around the same price and gold holdings started to be amassed aggressively in response to both the Euro-crisis and the belief that the FRB would unveil QE3 over the summer.

Clearly much now rests on gold's ability to stay above its key support which is created in a wide range between $1,525 and $1,575. We would have expected the first test of this support to result in a bounce but we are equally unsurprised that the metal has thus far been unable to repair the damage from last week. If ETF holders continue to trim holdings, the odds of the metal holding on to support will start to dim appreciably.

Another area of persistent deterioration for Brazil's economy in recent months has been job creation, as measured by the official CAGED index. This posted another disappointing reading today when the January report showed an estimated 28.9K jobs were created, well below expectations of 50K and a drop of 90K from the level of January 2012. This takes the trailing 12 month ma down to 84.8K, the lowest level since November 2009 and almost exactly half the pace of job creation seen a year ago.

Thus far the collapse in job creation has not been reflected in the official unemployment statistics, which have continued to improve in recent months. Whether this reflects a genuine inability or unwillingness of employers to fire employees or is simply a statistical quirk is unclear, but given that the CAGED index has been in such a consistent downtrend for the last 18 months we tend to believe its more cautionary data than the much stronger conditions reflected by the official unemployment data.

Brazil's capital flows continued to deteriorate in January with the Current Account widening to a record -$11.37 bln, significantly larger than the estimated -$9.6 bln level. Meanwhile Total FDI slipped to $3.7 bln, below expectations of $4.8 bln and a drop of -$1.7 bln (31%) from the level of a year ago.

This means that for January alone Brazil had a funding gap of -$7.67 bln. Over the last 12 months Brazil has still enjoyed a funding surplus of $5.0 bln, but this figure was $15.16 bln a year ago and $27.7 bln in September 2011, the high point for the current cycle and barring a significant rebound in either FDI or the Current Account this metric will slip into negative territory later in 2013 for the first time since the collapse of 2008/9.

It has been a couple of weeks since we published a note on the EM USD bond universe, during which time the space has been relatively quiet after absorbing the steep losses of late 2012 and early 2013. As can be seen on the attached chart there has been a further deterioration of bond prices over the last couple of sessions with Latin American bonds in particular coming under selling pressure. Given the very poor performance of the Brazilian equity market since the start of the year this should come as little surprise. Thus far other regions look a little firmer but the fact that so much investment in this space is on an indexed and geographically dispersed basis means that the entire complex tends to move as a unified group.

Unlike the prior sell-off when global interest rates were rising and therefore pressuring EM bond prices, recent sessions have seen developed sovereign yields either flat or a little lower. It is too early to make too much of this, but a widening of EM credit spreads would clearly pose something of a problem. Meanwhile investor flows remain stable, with shares outstanding in the EMB ETF virtually unchanged since the start of February. It should however, be noted that stable flows represent a marked change in overall conditions from that of 2012, since they do not provide additional liquidity for the bloated calendar of new offerings waiting in line to be issued.

We appear to have reached the point at which available inventory is the determining factor in the level of activity for the existing home market. This has very important ramifications both for home prices and new home sales, both of which can be expected to rise considerably in the months ahead.

January's NAR Existing Home data shows sales flat-lining at an annualized rate of 4.92mm homes, slightly above expectations of 4.90mm homes. This represents a rise of 9% from the level of a year ago. Single Family sales were 4.34mm units up 8.5% YoY and Condo Sales 580K, up 13.7% YoY.

However, the really interesting data in the report came in the form of inventory. Single Family home inventory has collapsed to 1.550mm homes, the lowest level seen since March 2000. This represents 4.3 months of sales, which is the shortest period since May 2005 but the conditions today are the opposite of 8 years ago when the ratio was depleted by soaring sales even as inventory was rising strongly to record levels. Quite simply in a number of geographical areas there appears to be a genuine shortage of homes relative to demand. The same is true of Condo inventory, which fell to 194K, the lowest since June 2001.

The implications of this are two-fold. Firstly given the extreme affordability of housing, prices can be expected to rise fairly rapidly in the tighter markets. Indeed the median existing home price has already risen by 12.6% over the last 12 months, the fastest pace since late 2005. This should help free up some additional inventory, both in the form of bank distressed sales and also existing home owners who will suddenly find their homes back up in value above the existing mortgage.

The other impact should be upon new home sales and construction, since potential buyers may find that the limited inventory available in the existing home markets forces them to consider purchasing a new home as an alternative. Thus although sales activity itself is little changed in recent months the entire dynamic of the marketplace appears to be shifting into a different phase of the cycle.

US Initial Claims moved back up to February 16th from last week's level of 341K (revised 1K higher from the initial reading). However the loss of President's Day meant that 11 states had to estimate Claims for the week which heightens the odds of a substantial revision in next week's report. Overall the impact on the 4 week ma was negligible , while the 10 week ma ticked higher from 355K to 357K. Attention will now start to be drawn towards next week's Non Farm Payroll report, which once more will fall on the 1st of the month. The fact that this session will also include Personal Income and the ISM Manufacturing survey, highlights next Friday as the key day for US economic data over the next few weeks.

Link to minutes:

http://www.federalreserve.gov/monetarypolicy/fomcminutes20130130.htm

The minutes from the FOMC January 2013 meeting show on the one hand a whole-hearted degree of the support for the concept of "unorthodox" monetary policy combined with some dispersion of opinion as to how it should be conducted. We have questioned many times the wisdom of the FOMC's brave, new path but we accept that (un)employment data is now the key influence over US monetary policy whether we like it or not. This still allows for a tussle between "doves" and "hawks" over the coming months and the battle lines now seem to be drawn.

On the dovish extreme we note that:

Despite a headline miss for the overall Housing Start data, the January 2013 report on estimated Home Starts and Permits is a solid report that shows a clear trend towards higher rates of activity in the US residential construction industry.

Overall Starts fell to 890K vs 920K consensus, but December's already strong data was revised substantially higher from 954K to 973K. Furthermore all of the shortfall in Starts was caused by the volatile Multi-Family segment, which fell back from a very strong 352K in December to a still respectable 277K in January. The 12 month ma of this metric has risen from 179K in January 2012 to 253K in January 2013, a reflection of how strongly Multi-Family Starts have rebounded.

Meanwhile the more important Single Family data enjoyed a modest increase to 613K from 608K, taking this data up to its highest level since July 2008. This represents a 20% increase on the level of activity seen a year ago, but even so activity remains well below normal levels allowing substantial growth to take place in the months ahead.

Permit data was somewhat less volatile this month with Total Permits reaching 925K, the highest reading since June 2008. Single Family Permits were 585K, up 29.2% from a year ago while Multi Family Permits also broke out to a new recovery high of 341K, reinforcing the fact that the slippage in Multi-Family Starts data is simply statistical noise.

FDI into China has been in a declining trend since late 2012 and 25 out of the last 26 monthly reports have shown a YoY decrease in FDI. January 2013 saw a total of $9.27 bln invested, a decrease of 7.30% from January 2012 and the lowest January report since 2010. Over the last 12 months FDI has on average been -4.07% below that of the prior year. Although this is not a steep drawdown, it should be remembered that China's reported GDP growth has remained in high single digits for this period, with much faster growth claimed in a number of capital intensive portions of the economy. The slowdown in FDI therefore represents an interesting pull-back by foreign investors at a time that capital remains in demand.

Of course some of this slowdown in FDI could be a reflection of the massive domestic credit issuance that has taken place over this period (around $2.5 trln compared to annual FDI of $110 bln), but our sense is that China has proved to be a much trickier investment destination than many realized and that this has led to a tempering of enthusiasm for FDI in recent months.

The NAHB Homebuilder Sentiment Index ticked lower to 46 this month (consensus was for a 1 point rise to 48) but this keeps overall sentiment at a much healthier level than it was going into the 2012 spring selling season.

The main cause of the drop was a down-shift in Traffic, from 36 to 32, but we note that this metric has persistently lagged both Present and Future sales (which were 51 and 50 respectively in February) during the recovery in the New Home market. In other words, there has been something of a qualitative shift in site visits, with a larger proportion of them leading to sales than was the case in the prior sales cycle. Given the depressed level of sales this makes sense, gone are the days when "window shopping" for a new home constituted a leisure activity. Instead those who actually bother to turn up at a site are more likely to be serious about purchasing, a fact also reflected in sharply lower cancellation rates once a contract has been signed.

The ECB's balance sheet continues to contract at a fairly rapid clip, although it appears that the impetus remains a purposeful draining of the deposit facility by private sector banks who presumably have better uses for their funds than to leave them in a non-interest rate bearing account at the ECB.

At the level of the overall balance sheet the ECB's assets (less gold) dropped by -€11.8 bln (-0.51%) this week. Since the end of August (which coincides with the end of the acute crisis in sovereign yields) the balance sheet has dropped on all but 2 weeks, falling a cumulative -€333 bln (-12.5%) over this 4½ month period.

However, if we allow for the rapid draining of the deposit facility, the ECB's other assets grew by €13.5 bln (0.62%) last week, and has fallen by -€120 bln (-5.2%) since the end of August. This strikes us as a more manageable pace for financial markets to deal with. The trouble remains that private sector banks may be underestimating their own liquidity needs when seeking to pull funds rapidly out of the deposit facility and in any case overall liquidity is still dropping at a fairly fast pace.

As we have suggested before, given the confusing picture regarding liquidity provision it makes sense to monitor stress indicators quite closely. We have therefore attached an updated the Bloomberg Eurozone Financial Conditions index (BFCIEU), which we have overlaid with a chart of the US equivalent during 2010 (when the FRB arguably underestimated the liquidity needs of the US market). Thus far the BFCIEU remains quite healthy at +0.32 (0 being "normal" conditions) and seems to have stabilized after having fallen quite sharply a couple of weeks ago. This means that the benefit of the doubt remains in favor of Eurozone markets, but we would still prefer to see a little less shrinkage of the ECB's balance sheet going forwards.

Although Spain's domestic economy remains deeply troubled by its prolonged housing bust, the export driven portion of the economy enjoyed its best year on record in 2012. Overall exports for 2012 reached €222 bln, an increase of 8.8% over the pace of 2011. Since the prior cycle peak was recorded in 2007, exports have risen by €52 bln or 30%, suggesting that domestic capacity that used to find demand at home has been able to find alternative markets overseas.

Imports diminished in 2012, falling just over -4% to €253 bln, this remains well above the trough activity of 2009 when they totaled a mere €208 bln. This is a useful reminder that although the fiscal issues are much more daunting today than they were 4 years ago in other senses (that are arguably more pertinent to the local equity market) activity is stronger today.

As would be expected robust exports and softening imports have had a dramatic effect on Spain's trade deficit. This totaled -€30 bln for 2012, over a third less than 2011's -€46.3 bln and the smallest deficit since 1998.

In our weekly commentary we described how gold's long range-bound performance has started to cause a marked deterioration in its relative performance against the US equity market in recent months, with the metal falling -6.47% in the prior 12 months ending February 15th compared to a +15.85% total return delivered by the SPX, a relative performance gap of 21.25%. Indeed even over a 3 year period the metal has returned slightly less than the SPX index (46.03% vs 48.10%), despite its very strong gains recorded during the Eurocrisis and introduction of QE2.

As the recent 13G filings for Q4 2012 have made clear, gold's poor relative performance has not gone unnoticed by a number of prominent hedge fund managers. While there has not been much public comment regarding the metal from this industry in recent weeks, actions speak louder than words, and some large holdings were either slashed or eliminated entirely between September and December 2012.

What is intriguing is that during this period total global ETF holdings (which are dominated by the GLD ETF) continued to climb, growing by a total of 3.4%. This indicates that there were other, dare we say less sophisticated, buyers of the metal. The transfer of an asset class from stronger to weaker hands is a process known as "distribution" and is normally followed by a sharp move downwards as the new holders discover they have rather less company than they assumed at the time of purchase. The unusually broad public dumping of the metal by a number of respected fund managers does therefore create a risk that sentiment towards the metal could start to deteriorate rapidly in the coming sessions.

Regarding the metal's price action we note that the support level around the $1650 level appears to have given way, leading the metal to probe the congested range between $1525 and $1625 at the time of writing. At the very least we would expect to see the metal test the lower band of this support in the coming weeks.

This week's Initial Claims data showed estimated jobs losses of 341K, well below consensus of 360K and last week's level of 368K (revised up by 2K). This drop is actually a little more important than it might seem, since we are now out of the year end season when seasonal adjustments can exaggerate moves in the data. Indeed a number of strategists had compared the good January data to what happened in 2008, when a similarly positive start to the year turns into an ugly spring for employment data.

As it is, today's report keeps the 4 week ma close to the key 350K level. Due to the very volatile series of recent reports we have decided to include a chart which extends the average out to 10 weeks; this has the advantage of being able to clearly demonstrate the substantial improvement to the data that has taken place in recent months. At present the 10 week ma is 355.6K, its lowest level since March 2008, and about -18K (-5%) lower than the level that was in place a year ago.

This morning's Eurozone GDP report showed a modest contraction of GDP across most of the union took place in Q4 2012, with activity estimated to have slipped by -0.6% over the quarter (annualized) and -0.9% over the year. This was slightly worse than consensus of -0.4% and -0.7% but although this gives the headline writers an easy story to fill the news void, a variance of this magnitude is statistically irrelevant.

As would be expected equity markets are down slightly on the news, which no doubt will have a short term impact on market sentiment. However, it should be remembered that corporate earnings for Q4 2012 were generally solid in Europe, underlining that a divergence between the corporate and overall economy seems to be taking place.

If today's news has any meaningful impact it will be to keep pressure on the ECB to maintain generous liquidity provisions within the financial system. In this regard we note that the BFCIEU index (which tracks Euro-zone financial conditions) continues to stabilize around the +0.3 level. Should the index continue to hold around this level a healthy divergence with the experience of the BFCIUS (which tracks US conditions) in 2010 would start to develop, which in turn would give us some comfort regarding the odds of a correction at the current time.

Back in 2011 it appeared as if Turkey's ballooning trade deficit would cause a destabilizing drain on its currency and FX reserves, both of which dropped sharply over the course of the summer. In the event, matters stabilized and Turkey has become one of the favorite destinations for debt and equity investors alike, leading to very powerful gains in both markets over the course of 2012 and a stable currency (although the TRY remains well below its value in late 2010).

One of the factors behind flows to Turkey has been the lowering of interest rates in Brazil and the generally poor performance of its local equity market. Although Turkey and Brazil would seem to have little in common, in the minds of global investors both are associated with high interest rates and economies that are on the border between developed and emerging in stature. It should be added that both experienced hyper inflation in recent decades before transitioning to a much more stable monetary environment. Unfortunately in both cases some of these vital lessons have been forgotten in recent years, and government intervention in Brazil and Turkey's economies has become increasingly prevalent.

As can be seen on the attached chart debt investors have become increasingly enamored with the Turkish story, with monthly flows into Turkish debt averaging $2.655 bln per month in 2012 for a total of $31.86 bln. Over the last 4 months of the year (when QE3 was dominating investor allocation decisions) these flows averaged $4.16 bln, which is an annualized rate of $50 bln. The importance of these flows cannot be overemphasized, both for providing corporate liquidity (much of Turkey's debt is issued by local banks which allows them to accelerate loan issuance) and at the national level for stabilizing the currency and reserves and lowering debt service costs on the national debt. Unfortunately flow-based economies are vulnerable to a shift in investor behavior, and given our misgivings about EM debt in general it should come as no surprise that we view Turkey's current market boom with suspicion.

India posted its second widest ever trade balance in January with the deficit reaching -$19.996 bln, and increase of 13.8% from the level of a year ago. The primary cause of the deficit is surging imports, which rose 6.1% YoY, while exports have stagnated over the same period growing a mere 0.8%. Although Oil and related products remain the largest portion of imports, it should be noted that non-oil imports grew by 5.7% over the same period.

In any event the soaring deficit is a growing problem for India, with the trailing 12 month ma reaching $16.67 bln, or an annualized rate of $200 bln. At the current rate of deterioration the total deficit for fiscal year 2012/13 could conceivably exceed 10% of GDP. With oil related imports largely out of the governments hands we would expect further consideration of tariffs on gold, which is the area of imports that could be most easily addressed without interfering with actual economic activity. In the meantime it is now clear how reliant the local currency is on foreign investor flows, which are currently running at a record pace for the start of the year.

This story neatly encapsulates two of our recurring themes, excessive issuance in the global corporate bond market and deteriorating economic conditions in Brazil. As would be expected the poor performance of credit in recent weeks is starting to put pressure on issuance, with the market finally showing some signs of discriminating between higher and lower quality offerings.

It would now appear to be very difficult for the more marginal issuers to come to market, which means that those in most need of additional funding will now find it hard to access. In our experience once the funding window starts to shut the difficulties spread fairly rapidly from the periphery to the core of the market. Much will depend on the performance of fixed income going forwards, and the willingness of global investors to commit yet more capital to this crowded trade.

The monthly JOLTS report on US job openings is a relatively junior statistic (not necessarily in terms of accuracy, more from the point of view of market impact) but given the FOMC's preoccupation with employment, we are paying somewhat more attention to this area.

The December report estimated total job openings at 3623K, down from 3790K in November, after the latter had been revised strongly higher from 3676K. We are not concerned about the monthly dip given the zig-zag course that the data takes from month to month. What we would point out is that the trailing 12 month average for December was 3623K, 12.3% above the level of December 2011, suggesting that a meaningful increase in job openings took place over the course of 2012.

The current level of job openings is similar to that of the summer of 2008 when the economy was slowing rapidly and openings were starting to collapse, and also the spring of 2004 when the FOMC was just beginning to raise interest rates from their cycle floor of 1.00%. The substantial improvement in openings in recent months does suggest that the unwillingness of employers to re-hire may be somewhat overstated at the current time. Although the prevailing rate of unemployment remains abnormally high, the speed of repair is starting to look quite normal across a broad array of employment statistics.

Link to Interview:

http://www.bloomberg.com/video/marketfield-s-shaoul-on-investment-strategy-vEL2W_neSSSvqs7S~9XyHw.html

We have rarely seen a clear a mismatch between enthusiasm for a market and local economic conditions as exists in India at present. While YTD flows have reached $7.6 bln by mid February (which is a $60 bln annualized pace) economic data has been dour and earnings disappointing. Despite these flows the local SENSEX index has stalled at the 20,000 level while the BSE Small Cap index has fallen -12.4% since peaking on January 7th.

This morning's Industrial Production data added to concerns, with December's index reaching 179.3 a -0.6% drop from the level of December 2011, compared with expectations of a 1% increase. November's data was also revised lower from -0.1% to -0.8%, which means that over the first 9 months of the 2012/13 fiscal year Indian Industrial Production has grown by a mere 0.7%.

Growth at this level is crying out for monetary relief, but with the relatively new CPI series (data commences January 2012) reported at a record 10.79% in January, up from 10.56% in December and 7.65% in January 2012 the leeway of the RBI to ease up is extremely limited.

Link to Statement:

http://www.realtor.org/news-releases/2012/10/fourth-quarter-metro-area-home-prices-show-strongest-performance-in-seven-years

The Q4 2012 National Association of Realtors report into the US Home market makes for fascinating reading since it underlines the broad strengthening of conditions across the US market while making it clear that affordability of US homes remains at historically high levels.

Median home prices rose in 133 out of 152 "metropolitan statistical areas" (MSAs) on a YoY basis, which compares to 29 MSAs showing rising prices in Q4 2011. We have included a link which shows the geographical breakdown of rising MSAs, which underlines that this has become a national recovery of home prices in recent months.

https://maps.google.com/maps/ms?msid=216703198201068244093.0004c767c88c10835ad29&msa=0&ll=45.274886,-77.080078&spn=52.670678,135.263672

Even so thanks to record low interest rates housing remains unusually affordable. The NAR calculates affordability using median home prices and standard FHFA mortgage terms based on a 20% down payment. This is then compared to median income (currently $61,481), with an Affordability of 100 meaning that 25% of income is used for mortgage payments. At present this ratio is at 193.5 on a National basis while Regional Affordability runs from 248.1 in the Midwest to 152.6 in the West. Detroit has the highest Affordability out of any single MSA with a remarkable 571 reading, meaning that it would take less than 5% of Median Family Income to service an FHFA mortgage on a median Detroit area home.

Given the sharp drop in inventory levels and current Affordability of housing in most MSAs, we would expect to see a strong trend of rising prices emerge in the coming months, with an increasing number of regions exhibiting boom conditions (as is already the case in Manhattan, Brooklyn and certain West Coast markets). At some point this may start to cause unease at the level of the FOMC, which seems to be quite unaware of the rapid change in the tide of the housing market, although it is aware that it stabilized in recent months.

In our experience few markets rebound with the ferocity of housing, whose granular and highly personal nature means that it tends to be a transaction in which power resides wholeheartedly with either the buyer or seller. The former have held the whip-hand for the last 7 years but this would appear to be changing rapidly from coast to coast at the current time, with higher prices being a predictable outcome.

India's Domestic Passenger Car Sales for January 2013 were 173.4K, -12.5% below their level of January 2012 (198K) and the recent month's data suggests that at best car sales have stalled, while at worst a tangible deceleration is taking place. Given that the data is not seasonally adjusted and the two most important months of the year for sales are February and March (the latter being the last month of India's fiscal year) we cannot be sure of the degree of deterioration before these two months have seen their sales reported.

However, given that 2012 saw record activity of 211K and 230K in these months it would seem likely that some shortfall will take place in 2012/2013 once the data is complete. At present the trailing 12 month ma of sales is 166K, compared to 169K at the end of fiscal year 2011/2 and we would expect to see further slippage by the time the year is complete.

An interesting story that suggests that we are finally seeing some signs of indigestion after investors gorged on a cascade of corporate issuance in recent months.

Although there has been a moderation of issuance there is clearly still strong appetite in place for credit, especially at the low end of the quality range where yields remain higher. We note the success this week of Chile's GeoPark (a no cash flow oil energy company) and that of Russia's VimpleCom (a junk rated mobile telephone provider) in issuing new bonds that were substantially oversubscribed. We doubt that overall demand will be choked off unless and until safe haven sovereign yields force their way up another 25-50 bp, but the stresses are starting to build in the fixed income marketplace.

This shift in the timing of the Lunar New Year from 2012 to 2013 has caused a massive (but understandable) distortion in all Chinese data for the current month. This means that we will have to wait until February's data is published in order to have a balanced view of how Chinese data has started 2013 and for the time being we will simply report that January data for both money supply and loans and trade (in a separate note) without drawing too many conclusions from them.

As would be expected from the above January was a very strong month for Chinese financing. Total Social Funding reached an all time high of 2.540 trln CNY ($420 bln) of which New Yuan loans represented 1.070 bln CNY or 42.1%. This is the largest amount of monthly issuance since January 2010, just beating the "double months" of March 2012 (1.011 bln) and January 2011 (1.042), but not suggesting a genuine acceleration of loan issuance.

Where the real bloating took place was in the rest of the Social Funding categories, with Bankers Acceptance bills being a massive 581.2 bln. This would appear to be short term liquidity creation that should be reversed next month, but we will have to wait for confirmation. Other categories were less egregious (at least when compared to the frothy activity of prior months) with FX loans at 179 bln CNY (148 bln in December), Entrusted loans 206.1 bln CNY (207.8 bln), Trust loans 205.4 bln CNY (264.1 bln), Non Finance Enterprise equity 24.4 bln CNY (13.5 bln) and Corporate Bonds 220.1 bln (207.3 bln).

The last few months of aggressive credit creation have started to have an effect on the monetary aggregates with both M1 and M2 now growing in the mid teens on a YoY basis. In the case of M1 this annual growth rate is somewhat distorted by the sharp January 2012 decline (-6.84%) falling out of the annual comparison, but it is also true that over the last 6 months M1 has grown by around 8.2%. If we allow for some reversal in February this would still probably translate into annualized growth of somewhere between 12-15% at present, which is something of a change from the very tight levels seen in mid 2012.

As we have described before, China's monetary conditions have been transformed from a liquidity crunch into a credit driven expansion. Although at the level of monetary data this may appear to be a re-run of the last decade's boom it is a very different set of affairs, and one which involves significantly more risk of abrupt slowdown and distress should the credit granting mechanisms come unstuck.

China's economy has effectively replaced "permanent" liquidity (in the form of the PBOC's balance sheet growth) with much shorter term financing, in a national move towards wholesale funding lines and credit instruments. This represents a down-shift in stability of an order of magnitude, but we would grant that the party could still continue for a while longer.

As would be expected, given the robust performance of the Euro since the start of the year, the SNB was not required to intervene in the FX market during January. As a result, SNB FX reserves ticked downwards by 147 mln CHF (-0.03%) to 427.04 bln CHF. This still keeps them at near record levels and means that they have increased by 198 bln CHF (86.1%) over the last 12 months. Clearly building up reserves is proving to be a much easier proposition than draining them, and we would not expect any concerted effort to sell Euros into the market for a number of months.

Meanwhile we have seen a marked drop in appetite for Swiss treasuries, with only notes of 2 years maturity and below now generating negative yields. This is perhaps one of the first signs that the inflationary pressures of the build up in reserves is starting to be appreciated by the market.

US Initial Claims data showed an estimated 366K Claims for the week ending February 2nd, just above consensus of 366K. Last week's data was also nudged higher by 3K to 371K. This has allowed the 4 week ma to fall to 350.5K, a new 5 year low, as the elevated January 4th data has fallen out of the calculation. All things being equal we would expect a modest rise in this metric over the next couple of weeks, with it settling somewhere between 355K and 365K. It should be noted that the improvement in Claims data in recent months was belatedly verified by a large positive revision to the 2012 BLS Non-Farm Payroll data, and that although the Unemployment rate (which relies on the alternate Household survey) moved slightly higher, the balance of employment data now indicates a steady and significant improvement in employment conditions has taken hold.

We continue to track the notable under-performance of Brazil's equity market versus its global peers. At the time of writing the IBOV index is down 3.44% on the year in local terms (0.27% for USD investors), making it the worst performing global market in 2013. This follows poor relative performance in 2012 (+7.40%) and terrible absolute performance in 2011 (-18.11%). Brazil has thus fulfilled our prediction made in 2011 that it would enter a bear market that would remain in place for as long as three years, a process that we do not yet believe to have been completed.

Central to this poor performance has been the energy sector, which had previously acted as leadership during the 2002-8 bull market. The grandiose plans to develop the massive offshore "pre-salt" deposits have proved to be far more expensive than original estimates, which has compressed the earnings of many of the companies associated with their development. An additional source of stress has been the increasing intrusion of government into the energy sector, with adverse impact on both costs and the overall quality of decision making.

As can be seen on the attached chart, the MSCI Brazil Energy Index (MXBR0EN) is now within 7% of its 2008 low, having fallen over 60% from its 2009 recovery high. At the very least we would expect this index to fully retest its 2008 low in the weeks ahead, at which point the index would be back to where it was in late 2005, before the majority of investors ever considered investing in this area.

The MBA Purchase Mortgage Application index continues to indicate a pick up in demand for new mortgages with the weekly index moving up to 215.8, its highest level since May 2010 when home purchases were being boosted by home-buyer tax credits. Perhaps more importantly the trailing 10 week ma has now pushed above the 200 level for the first time since mid-2010, suggesting that the winter months have seen a pickup in home purchases by actual users as well as powerful demand from financial players.

Clearly if this is sustained into the key spring selling season this will be good news for a number of housing markets. It may however be less good news for MBS holders, who have benefited from a shrinking pool of outstanding instruments over the last 5 years. Although the FRB is currently soaking up a significant number of bonds under its QE3 program, these efforts may start to be neutralized by growing issuance in the weeks ahead.

Following the balance sheets of major central banks has never been as complicated (and by implication as important) as it is today, with increasingly complex actions requiring some flexible thinking on the part of the observer.

The ECB's balance sheet is a good example. First it has to be remembered that under the LTRO the ECB became a lender of last resort rather than a buyer of last resort (a distinction which caused most observers to dismiss the policy as ineffective a year ago). The importance of this became apparent last week when the first voluntary repayment window of funds borrowed under the LTRO received substantially more bids than had been expected.

Given that funds borrowed under the LTRO incur an interest rate charge and deposits held by the ECB are no longer paid interest it makes sense that banks chose to repay a decent portion of borrowed funds which had not been used to purchase higher yielding assets. Indeed the ECB deposit facility has collapsed from over €800 bln last July when interest was still paid to €176 bln today (see chart). Given that these funds were entirely passive and had not added to demand for local financial assets, the draining of this facility has had little adverse impact on local financial conditions.

Funds which had been borrowed and placed into low yielding high quality assets (for instance the German 5 year note yields 0.70%) would also be likely to be repaid, and this perhaps explains some of the recent spike higher in yields from their ultra-low levels of late 2012. Here the impact is less benign, but not yet problematic. We would argue that a European bank that borrowed under the LTRO to purchase dislocated Spanish or Italian credit would still be highly motivated to hold onto its debt given the generous spread in yields.

What this means is that in measuring aggregate liquidity provided by the ECB it is now necessary to track not just overall assets held but also assets net of the deposit facility. We have attached a chart that performs this function (in both cases we have removed gold holdings from the calculation since these fluctuate in value without impacting liquidity). If one looked at the ECB's total balance sheet (ex gold) it would be shown to be growing by a mere €92.3 bln (4.1%) over the last 52 weeks and to have shrunk by -€337 bln (-12.6%) from its June 2012 peak. Taking away deposits on the other hand would show the balance sheet growing by €422 bln (24.4%) over the last 52 weeks and to have shrunk -€201 bln (-8.5%) from its August peak.

Either way the ECB would be shown to be draining liquidity a little early for our liking, but to the extent the brunt of selling pressure has been on the passive deposit facility and safe haven yields we are not unduly concerned provided we see a pause in this contraction going forwards.

The PBOC was tardy in releasing its December 2012 balance sheet but the data was posted early this morning. At first glance it would appear to show decent growth in local liquidity, with the total assets held growing by 465 bln CNY or 1.61%, the largest increase since January 2012. This takes the 12 month RoC up to 4.8%, which is the fastest growth since March (although still well below the rate of GDP and credit growth).

However a closer inspection of the data shows that almost 70% of December's increase comes in the form of "Other Assets", a small side pocket of the PBOC's balance sheet which mysteriously grew 324 bln CNY (41%) in December to reach 1104 bln CNY. This is the second consecutive spike in this category (in November it grew by 161 bln CNY or 26%) and we would suggest that this portion of the increase in the balance sheet does little to impact on local liquidity conditions.

The bulk of the balance sheet remains in the massive FX holdings, which grew by 146.6 bln CNY (0.62%) in December. This is somewhat faster than recent months and takes FX holdings up to a new record. However, it also means that over the course of 2012 FX holdings only grew by 1.84% which compares to growth of 12.39% in 2011, 18.05% in 2010, 17% in 2009 and 29% in 2008. In other words 2012 has seen a dramatic shift in the provision of local liquidity from the PBOC's FX holdings, which by implication suggests that export growth is somewhat weaker than official data suggests.

We remain concerned that China's credit creation is expanding far quicker than local liquidity, and that while the latter may appear to be abundant (the PBOC still controls a balance sheet that dwarfs the FRB and ECB in a much smaller economy) it is changes in conditions and not their absolute level that ultimately matters.

The FRB Loan Officer Survey for the 3 month period ending January 31st 2013 was released today and showed little change from the last few periods in the lending standards for Commercial and Industrial (C&I) loans. Out of 68 banks responding, 63 claimed that Lending Standards were unchanged (dark blue) while 5 claimed to have "eased somewhat". This compared to 59 unchanged, 6 "eased somewhat" and 1 "tightened somewhat" (the total fluctuates from poll to poll) for the period ending October 31st 2012.

However, the fact that standards are reported to be largely unchanged does not mean that C&I lending itself is static. Indeed as the attached chart shows the weekly H.8 report shows that C&I loans outstanding have risen by over 12% over the last year, despite the fact that this period has also seen record corporate bond issuance. It may be that credit remains hard to obtain for some credit-worthy enterprises (particularly for smaller firms), but overall the US business sector would seem to have ample access to capital at the current time even without a substantial easing of credit standards.

So far February has proved a much more difficult month to navigate than January, with some sharp reversals in global equity markets over the last two sessions, especially in some of the European peripheral markets that we expect to do well over the course of 2013. We are yet to see much to concern us, other than the ugly reversal of gains, and take some consolation from the fact that early asset cycles are typically punctuated by long grinds higher and violent reversals. All we can say at present is that we have seen both.

Where we do see more cause for concern however is in the very popular world of USD denominated emerging market credit. This has performed poorly for a number of weeks and the steady creep higher in developed sovereign yields would seem to have punctured the euphoria which levitated bond prices to remarkable levels at the end of 2008.

Indeed just as the ushering in of QE2 in late 2010 was accompanied by a rush into emerging market equities that created an important top in many markets, the creation of QE3 appears to have caused the same process to take place in EM USD bonds. Attached are the bond prices of four widely held sovereign credits, each of which has a maturity date after 2030 and is a significant holding of the popular EMB ETF (which tracks the JP Morgan EM Bond index and is the largest ETF in this area). As can be seen each bond made its high around the same time in late 2012, following a rush of capital into this product and other international bond funds.

Although these flows continued to remain in place through most of January, bond prices started to falter almost as soon as 2013 opened for business, with losses accelerating towards the end of January. In recent days these losses would seem to have caused some disquiet amongst investors, with ETF shares outstanding (red line on chart) shrinking by 3.8mm to 53.8mm shares since mid January, the steepest ever draw-down in shares outstanding during the charmed life of this ETF.

Although at this stage bond price declines and investor redemptions are yet to really start feeding on one another, the danger is clearly present in what remains a crowded trade with insufficient underlying liquidity to accommodate sharp changes in flows without abrupt price disruption.

We have been following the UBS Swiss Real Estate Bubble Index for the last few quarters as a rough gauge of the domestic asset inflation being caused by the SNB's staunch defense of the local exchange rate. For new readers this measure is published quarterly and uses the relationship between purchase and rental prices, the relationship between house prices and household income, the relationship between house prices and inflation, the relationship between mortgage debt and income, the relationship between construction and gross domestic product and the proportion of credit applications for residential income property by UBS clients.

The index is calibrated such that readings below -1 = slump, -1 to 0 = balanced market, 0 to 1 = boom, above 1 = risk, above 2 = bubble. Of course such labels are subjective, and the direction and slope to the curve are as important as the level itself.

Q4 2012 generated a reading of 1.11, the second consecutive quarter in "risk" territory and the highest reading since Q3 1991, when the late 1980's property bubble was in the process of melting down into an ugly bust that claimed a number of regional lenders and took a decade to complete. That cycle peaked in Q4 1989 at 2.56, 9 quarters after the index first burst through the 1 level in Q3 1987.

Then, as now, Swiss mortgage rates were very slow to respond to the growing risk in local property and indeed as the bubble was forming in the middle of 1988 mortgage rates fell from 5.23% to 4.99% before rising over the next 4 years to peak at 7.89% (see chart). The average mortgage rate at present is 2.69% and has been virtually unchanged since early 2009, at which time the local property market was "balanced" but improving strongly. Although the FX pressures on the SNB have ameliorated (the EUR/CHF is at 1.23, above the intervention level of 1.20) there is no sense that the SNB is willing to countenance a rate increase at the current time. The likelihood therefore is that the local real estate market will continue to feed on itself, pushing further into risk and perhaps approaching bubble territory over the next few quarters.

Any lingering concern regarding the ISM Manufacturing Survey should have been banished by the January release, which showed the headline and all important sub-sectors moving back above the key 50 level.

The headline index reached 53.1, which is the highest reading since April and suggests some re-acceleration of industrial activity is taking place. Perhaps most importantly the New Orders index (red) moved back up to 53.3, the highest level since May. For obvious reasons this index needs to stay above 50 going forwards. Production (blue) dipped slightly to 52.6 but remains comfortably positive, some of which will have contributed to a strong bounce in Inventories (olive) from 43 to 51 (this is something of a year end phenomenon with most businesses trying to minimize year end inventories). Employment (pink) was also strong at 54, the best reading since June.

Overall this is a very solid report, which reflects the high quality earnings reported by most US industrial companies in the current earnings season, and suggests that Q1 2013 is off to a solid start.

This morning's non-farm payroll release was what we would call a "stealthy upside" report, since although the headline data for January was close to expectations (157K vs 165K for Total and 166K vs 168K for Private Sector) there were some very substantial upward revisions to prior releases.

Overall employment growth for 2012 is now estimated to have been 492K, or 41K per month greater than originally estimated. This is hardly trivial given that the original average Total Employment growth was just over 140K and 1601K for Private Sector payrolls. This actually makes perfect sense given the decent improvement we have seen in other data such as Initial Claims (but it leaves the ADP report looking somewhat foolish having revised all its data lower following the "improvement" to its methodology).

Following this release the 12 month ma for Private Sector claims has risen to 174K, which is comparable to the rate of growth seen in mid-2005 and the summer of 1993. It also removes any suggestion that 2012 saw a deterioration of employment data and in fact the very strong revision to November's data (which is now 247K Total and 256K Private Sector) actually suggests that some acceleration was taking place towards the end of the year.

Meanwhile the Household survey has taken a sudden turn for the worse with only 17K jobs added in January following gains of 28K in December and -51K job losses in November. None of this would matter much if the FOMC had not elevated the Unemployment rate into the uber-stat of this cycle, since this is driven by the Household Survey report. January's Unemployment Rate therefore rose modestly to 7.9%, taking some of the pressure off the bond market for the time being (assuming that it ignores the much more positive message from the more senior data).

In our experience the various forms of employment data can diverge significantly from month to month or even from quarter to quarter, but in the end they come into line with the majority view. The deterioration of the Household survey is therefore, we assume, a result of the data getting ahead of itself in the summer and early fall, but we would expect this adjustment to now be complete. Better data from this series should therefore start eating into the Unemployment rate again later this quarter.

Quite how following the myth of a measured Unemployment rate came to be regarded as acceptable monetary policy will no doubt be the subject of a future PhD thesis and we can only hope that its author has the sense to join the Private Sector once it has been completed.