As we had anticipated, Brazil's fiscal position has started to worsen rapidly in recent months. February's deficit was -23.3 bln BRL, significantly wider than estimates of -13.3 bln BRL. This is the largest February deficit on record (the 10 year average for February is 7.8 bln) and 14.5 bln BRL wider than the deficit of a year ago. Although we would make some allowance for the "Carnivale" factor, we do think that the magnitude of the miss suggests that an underlying deterioration of public finances has taken place.

This is also suggested by the Primary Balance (which excludes interest payments), which fell to a deficit of -3 bln BRL, compared to expectations of a 1.5 bln BRL surplus. The Primary balance generally only falls into deficit during November (occasionally) December (always) whereas February has seen an average surplus of 6 bln BRL over the last 10 years.

The only good news contained in the report was a reminder that at 35.7% Brazil's Debt/GDP ratio is far healthier than most developed economies, but the shift from surplus to deficit funding still has important negative implications at a time that the central bank and government are trying to manage a slowdown of growing magnitude in the local economy.

We have outlined the massive increase in non-bank financing in China and it would seem that the local regulatory authorities are finally starting to take steps to restrict the use of "wealth management" products to fund loans. Reports suggest that the regulator has instructed banks to restrict the use of wealth management products to fund assets that are not publicly traded. We view this as a thinly veiled attack on speculative real estate, which we understand has become increasingly reliant on this source of funds in recent months.

Should the authorities be serious in their attempt to clamp down, then the ramifications are significant. In general credit bubbles continue up until the point that local liquidity becomes unable to fund their progress. The two main factors are the pace of monetary creation and regulatory action (sadly tightening underwriting standards rarely play a part until delinquencies become an issue). In China's case the PBOC stopped increasing its balance sheet a year ago and now the second constricting force may be about to come into play. The odds of a sharp and disorderly constriction of activity have therefore hardened considerably. The local equity market apparently understood the message, with the SHASHR index falling -2.83% to 2340, the lowest close since the end of December.

We have commented several times on the rapid widening of India's trade deficit in recent quarters and this was reflected in a very poor Q4 report of the Current Account. This was estimated to have reached -$32.63 bln, well above expectations of -$30.7 bln, while the Q3 report was revised to -$22.6 from -$22.3 bln. The 4th quarter deficit represents about 6.7% of GDP, and would of course have been somewhat wider if it were not for the continued willingness of foreign investors to pour funds into local equities and fixed income products.

The massive current account deficit thus represents a key policy constraint over the RBI's wish to ease tight local monetary conditions, while also making India's currency and financial markets very vulnerable to any weakening of foreign investor demand for financial instruments.

The bail-out of the Cypriot banking system and consequent hair-cut on bank deposits has caused a marked deterioration of financial conditions across the Eurozone in recent days. The Bloomberg Eurozone Financial Conditions Index (BFCIEU) closed in negative territory last night for the first time since November 22nd and remained in negative territory this morning at -0.046. We would describe current conditions as neutral rather than concerning, but this marks a deterioration from the healthy readings of a few weeks ago.

It would appear that the main driver behind the deterioration has been a spike in the 10 year swap spread which has risen to 40.1 bp, its highest level since last August. Interestingly equity market stress, as measured by the VDAX remains quite modest at 16.16, compared to a range of 18-22 last August. In other words the stress build-up is thus far really limited to the internal funding mechanisms of the banking system, and has not yet widened to encompass more widely traded financial instruments. Should swaps quickly settle back down in the prior range then we would not expect much collateral damage elsewhere, but a more prolonged period of dislocation would be expected to get a little more attention in equity and credit markets than we have seen so far.

In a speech this afternoon at the London School of Economics (in honor of Mervin King, the retiring Governor of the Bank of England) Chairman Bernanke laid out a robust intellectual defense of what we have termed the "Bernanke Doctrine" (see link below).

http://www.federalreserve.gov/newsevents/speech/bernanke20130325a.htm

www.bloomberg.com/video/nordvig-shaoul-torres-on-mexican-peso-wArhYABfT9i9ICVkXyDbrQ.html

Attached is a link to the panel discussion on the Mexican Peso at last week's Bloomberg Mexico Summit March 22nd. Comments by Shaoul appear at 1 min 39, 7:50, 13:25, 14:50, 15:50, 17:09, 21:29 and 24:35.

As the first quarter draws to a close, one of the most striking aspects is the large degree of outperformance shown by the SPX index against most emerging markets. With 4 trading sessions left the former is up 9.7% (including dividends) while the latter has slipped -3.57%, despite very strong inflows into most of the emerging market complex.

One clear factor behind this underperformance has been the generally poor quality of economic data (and earnings) reported in recent months. A very rough measure of this is captured by the Citigroup EM Economic Surprise index (a counterpart to the more widely followed Citigroup US Economic Surprise index). This has been mired in negative territory for most of the last 11 months and its 50 day ma has slipped to -13.2 (see chart). Although this in itself is not a deeply negative reading it is the persistence of negative data that has eaten away at local markets. It also suggests that we are not dealing with the sort of sharp collapse and rebound seen in 2008/9, but a more general (and permanent) downshift in economic activity.

It should also be noted that expectations themselves have been trimmed in recent months, which means that the steady negative readings seen in recent weeks represent a continuous deterioration of data itself. The US by comparison has seen generally positive readings over this period. After bottoming at -65 in July, the CESIUSD index recovered strongly all summer and peaked above 60 in November. The index then fell back to -30 in January before recovering to +30 at the end of last week. However, it should be recalled that over this period expectations for the US economy have generally been rising, meaning that the overall picture is one of a steady improvement which participants still find beating their expectations more often than not.

The difference between these two environments can be seen on the attached chart, which shows the difference between the US and EM Economic Surprise Indexes. As can be seen for most of the last decade this has favored the EM index, but in the last two years the US index has generally posted better readings. Indeed since March 2012 the trailing 200 day ma has favored the US, which is a fair reflection that the "balance of good news" is now strongly weighted towards the US domestic economy and away from the majority of the EM complex.

Brazil continues to experience a sharp deterioration in its current account with February's data showing a monthly deficit of -$6.625 bln, well above projections of a -$6 bln deficit. This is a YoY increase of -$4.9 bln, which is the greatest annual deterioration on record and although given that it is February data and we would make some allowance for the impact of Carnivale, there is a pronounced trend towards wider current account deficits. Indeed the trailing 12 month cumulative deficit has reached -$63.4 bln, a record in nominal terms and $11.2 bln (21%) greater than the level of a year ago. As a percentage of GDP the deficit is -2.79%, which is the widest since September 2002 (see chart).

FDI on the other hand has stalled in recent months. February's total was $3.8 bln and the trailing 12 month total is $63.7 bln, a mere $0.27 bln above the level of the current account deficit (see chart). It seems quite likely that these two measures will now cross over for the first time since the 2008/9 crisis. Interestingly, despite the very poor performance of the local equity market, foreign flows into equities remained positive at $2,291 (see chart). It is hard to believe that investors' patience would survive another leg lower by either the market, which suggests that FDI could start to come under pressure at precisely the time it is needed to redress the growing current account deficit.

Economic Projections of FOMC participants:

www.federalreserve.gov/monetarypolicy/fomcprojtabl20130320.htm

In a move which was widely anticipated, the RBI elected to cut the local REPO yield to 7.50%. However, in its accompanying statement Governor Subbarao made it clear that the scope for further cuts was severely limited by a combination of the fiscal deficit, trade deficit and inflation. These have combined to weaken the Indian Rupee considerably in recent quarters, although powerful foreign investor flows into equities and bonds have stabilized the currency in recent months.

As a general rule, the point at which a central bank starts to address a domestic slowdown is a difficult one for investors, since the damage to the fabric of the economy tends to be quite significant for a central bank to act (this was certainly true in the US in 2001 and 2007, or for Brazil in 2011). In India's case the constraints caused by very poor economic management only exacerbate the dangers, as does the growing domestic political uncertainty caused by the defection of Prime Minister Singh's main coalition partner last night.

The ECB's weekly report on its balance sheet shows that the central bank continues to drain liquidity from its refinancing operations at a rapid pace, despite the recent flare up in Cyprus. On the positive side this is largely a voluntary process by Eurozone banks who are returning excess funds which they have no current need for (and saving interest charges as a result), but there is some risk that an overly rapid repayment may lead to some liquidity constraints going forwards.

In terms of the data the ECB's balance sheet shrank by -€18 bln last week, almost all of which came from repayments of funding operations (the LTRO being the largest). This took the balance sheet (ex-gold) down to €2,209 bln, its lowest level since December 16th 2011. This means the entire effect of the LTRO has now been extinguished as far as the size of the ECB's balance sheet is concerned (this is not true of its composition). Meanwhile the Deposit facility fell modestly to €132.6 bln, meaning that the balance sheet ex-deposits is now €2,077 bln, the lowest level since last July. In other words the draw-down in "useful" liquidity has not been quite as sharp. So far local financial conditions have remained in positive territory, with the BFCIEU currently at a healthy 0.26 (see chart) but we continue to watch this measure for any sign that the ECB's activity is starting to put some strain on local funding operations.

The PBOC finally published the January update to its balance sheet yesterday, some 6 weeks later than would normally have been anticipated (it is unclear if this is due to the Chinese New Year or simply a matter of internal priority). In any case the data continues to paint a picture of very sluggish growth at the level of monetary base at a time that domestic credit issuance has been growing by over 1.2 trln CNY ($200 bln) a month.

The January report showed the PBOC's total assets to have grown by 339 bln CNY (1.15%) in January, but it should be borne in mind that January is typically a very strong month for monetary growth as the authorities maximize liquidity before the New Year holiday. For instance January 2012 saw growth of 5% and January 2011 growth of 3.75%. The YoY increase in assets was 290.75 bln CNY (1%), which is the smallest increase in nominal terms since the data starts in 2002. Thus the last 12 months have combined the fastest ever base of domestic credit creation with the smallest ever increase in domestic liquidity, a recipe for a problem if ever we saw one.

The effect of this can be seen on the ratio between the size of the PBOC's balance sheet to domestic loans outstanding, which has fallen from a peak of 0.66 in March 2008 to 0.46 in January 2013, the lowest level since May 2005 (see chart). However, given that more than half of recent issuance has come outside of the banking system, and is therefore not captured by loan data, this ratio now greatly overstates available liquidity. If we included just the effect of the last 12 months of non-bank financing this ratio would have fallen to around 0.40. Should current trends continue there will come a point at which a domestic credit crunch will occur with predictable effects for local asset values. It is not the price of the latter which will determine the timing (value has been absent from domestic property for a number of years) but the availability of liquidity for additional financing (as was the case in the US in 2007). The speed at which this ratio is falling suggests that the terminal point of this cycle will occur rather sooner than most observers realize.

The February Housing Start and Permit report was the latest in a string of positive data for US Housing. Total Starts were estimated to be 917K, in line with expectations of 915K, while the January data was revised up to 910K from 890K. Most of the fluctuation in recent months has been caused by the volatile (but clearly improving) multi-family portion of the data, which represents around a third of total activity. Single Family Starts have enjoyed a much smoother progression and rose in February to 618K, the highest reading since June 2008.

Although the Permit data gets a little less attention, it has generally proved to be a more accurate measure of activity. February showed Total Permits of 946K, above expectations of 925K, while the January data was trimmed to 904K from 925K. This makes February the most active month since June 2008. Single Family Permits (the most important single statistic in the report) rose to 600K, again the highest reading since June 2008 and a 25% increase YoY. Given that Permit activity is still only two thirds of average activity over the last 40 years and one third of its 2005 peak we would expect to see a further acceleration of activity in the months ahead.

The NAHB Homebuilder Sentiment Index for March fell by 2 points to 44, compared to expectations of 47. It would seem that this reflects some bottlenecks experienced by some of the smaller builders who take part in the monthly poll, with the Total Sales sub index (black) falling to 44 from 47. We have not heard much in this vein from the larger public homebuilders, but clearly the improvement in the market's conditions took the industry by surprise and it would be no great surprise if some of the smaller players who cut back dramatically on staff and land holdings are experiencing some delays in ramping up business. We also suspect that the prices approved from the appraisal process may be lagging the improvement in the actual market (the same was certainly true on the way downwards), making it a little harder to obtain mortgages in some cases. As with bottle necks this would prove to be a temporary phenomenon.

Future Sales (blue) remained strong at 51 (up from 50) while Foot Traffic (green) improved to 35 from 32. The latter remains conspicuously weak compared to sales, which we believe is a reflection of a higher quality of prospective buyers. We wait to see whether the weaker NAHB data is reflected in either March's Housing Starts or New Home Sales data, but even if a modest dip were to be recorded (no guarantee given the differing methodologies behind these data sets) this would not in our opinion reflect a longer term deterioration in activity.

Amidst the ongoing debate about Italy's political and economic future the one factor that has had remarkably little attention has been the very robust performance of the local export economy. January saw a continuance of this trend and although the month generated a trade deficit of -€1.619 bln this is a very low deficit for what is seasonally the weakest month in the year. Indeed you would have to go back to 2002 for a smaller January deficit. The trailing 12 month ma of the Trade Balance has move up to €1.160 bln, which is the strongest performance since late 1999.

Moreover this improvement is almost entirely down to export performance. January exports were €29.8 bln, a rise of 8.7% over the prior year, with the trailing 12 month ma moving up to a new all time high of €32.7 bln. Imports by comparison fell -1.76%, indicating a modest reduction in demand for goods and services, as would be expected. Our contention is that export data is probably a much more accurate reflection of the performance of the country's local corporate sector (particularly that of large cap listed companies) than GDP data. The former suggests that conditions remain fairly positive while the latter paints a much more gloomy picture. To the extent that investors (and media) have followed the senior data, considerable value looks to have been created in the local equity market.

China's data for Retail Sales, Industrial Production and Fixed Asset growth for January and February combined was released over the weekend and appears to show a marked deceleration in Retail Sales in particular. At 12.3%, these have grown by the slowest pace since early 2004 (we ignore the January 2005 data since this was affected by the lunar new year), which runs against the general view that activity rebounded in late 2012. Industrial Production was disappointing as well at 9.9%, the slowest growth since early 2009 when China was still feeling the drag of the post-Lehman collapse. Fixed Asset investment remained buoyant at 21.2% and was the only area to beat expectations.

Setting aside the exact numbers (which are always open to dispute) the general trend of the data fits our view that China's economy has become far more credit driven in recent months, with Fixed Asset creation the primary beneficiary of this massive increase in leverage. Of course much of this activity has little or no future economic value (indeed the required maintenance may mean it has negative worth) and is far less beneficial than either industrial or retail activity, both of which we suspect are growing substantially slower than the official data suggests.

Meanwhile CPI is starting to move higher once more, with the February report shown a YoY 3.2% increase. This was somewhat higher than expectations and suggests that policy decisions are going to get increasingly complicated for the PBOC going forwards. Speaking of the PBOC we should report our frustration that it still has not released an updated balance sheet since December 31st 2012. Given its wish to be considered an elite central bank this is something of an embarrassment from our perspective, particularly since its balance sheet data has rarely been as important as it is today.

Please note that since I will be on vacation for the week ending March 15th there will be no further daily updates. We look forward to resuming coverage next week.

In a somewhat surprising move the Mexican Overnight Rate was cut to 4.00% this morning from its prior rate of 4.50%. In making this decision the Banco de Mexico was led by the recent fall of local CPI back into the 2.00% to 4.00% policy band.

This may well be true, although one could also point out that CPI was above 4.00% between May and November 2011 and has not fallen below 3.00% at any point this cycle. The interest rate cut is therefore only marginally warranted by inflation data and comes at a time that the local equity market and other asset prices are close to multi-year or all time highs. Although we have no current concerns of overheating within Mexico's economy given its close ties to the US (where monetary policy remains extremely loose, and economic activity starting to accelerate) it would probably be wise for the central bank to avoid easing further in the months ahead.

The odds of an upside Non Farm Payroll report were reasonably strong given encouraging data elsewhere but it was still something of a relief to see the BLS estimate Total Payroll gains of 236K (compared to 165K consensus) and Private Sector gains of 246K (170K consensus). Revisions deducted -15K from December and January Total Payrolls and -6K from Private Sector Payrolls, meaning that the overall report was a substantial upside surprise. This data means that the trailing 12 month ma of Private Sector gains is 172K, in line with the data reported in June 2005 during the middle of the last employment growth period (and one year into the FOMC tightening cycle). It is also comparable to the pace of job gains seen in the summer of 1993, which marked the start of a sudden acceleration in overall activity and employment growth.

The even more erratic Household survey, which drives the Unemployment Rate showed gains of 170K, enough to reduce the the Unemployment Rate down to 7.7%, the lowest level since December 2008. It should be noted that the Household survey has been significantly weaker than the Establishment survey for the last few months, and given its mean reverting tendencies (see chart) should be expected to deliver one or more very strong readings in the next few months, which implies (but does not guarantee given that other calculations go into the rate) another sharp drop for the Unemployment Rate can be expected by the middle of the 2nd quarter.

Our belief remains that the FOMC is significantly underestimating the pace at which US employment is recovering, with important and negative consequences for those who have used the FOMC's statements as a basis for long term investment decisions.

The Lunar New Year has a very distorting effect on Chinese statistics, making them even less reliable than usual as a gauge of activity. February's holiday related collapse in activity was somewhat less than that experienced last year for exports, and somewhat greater for imports. This led to a YoY growth in exports of 21.8% and a -15.2% reduction in imports.

Regarding exports Hong Kong (which are then supposedly re-exported) continues to account for a surprisingly large amount of the total (17.9%), and this sub category grey by 35% YoY in February. There has been no similar surge in total Hong Kong exports but since these are calculated via a different methodology some claim this is a measurement issue, while others suspect that export activity is being deliberately inflated to meet official quotas. We fall into the latter camp, particularly since FX reserves at the PBOC have been growing much slower than exports in recent months (unfortunately the PBOC is late in reporting January 2013 changes to its balance sheet so our data cuts off in December).

Import growth on the other hand continues to look quite poor, particularly when compared to the gaudy growth rates claimed for industrial production, retail and fixed asset investment (February's data for this will be released tomorrow). Import data would suggest that domestically focused activity has slowed appreciably in recent months, while other official data shows a more stable picture.

In line with the overall figure, BRIC exports to China continue to be under pressure (see chart). Brazil's exports were $2.9 bln, a -17% drop YoY (we have already commented last week on the significant deterioration of Brazil's trade data). Russian exports to China were $3.2 bln, a -22.2% drop and India's $1.2 bln, down a massive -46.4% YoY. It would therefore seem that China's influence over other large emerging markets is starting to become a negative force with much faster declines in activity being reported than would generally be expected.

With the US bull market approaching its 4 year anniversary next week and the SPX index approaching a new all time high it is worth pointing out that the relationship between the US equity market and the USD has changed markedly over the course of recent months. Indeed the recent breakout by the SPX has been accompanied by a surge in the DXY index, with this strength not only coming from a weaker EUR, but also good gains recorded against the GBP, JPY and even the CHF.

This is actually part of a much longer trend in which the multi-year inverse correlation between the SPX index and the DXY index has eroded. This should come as little surprise, for although the USD does have safe haven status (and therefore strengthens during times of global turmoil when equities generally suffer) as a general rule markets that wrest global leadership away from the pack are accompanied by strengthening currencies. This is because strong performance attracts investment flows, which themselves create additional demand for the currency (and even stronger currency adjusted returns). This was the experience of the 1990s for the US and for emerging markets between 2002 and 2008.

Attached is a chart which shows the SPX (blue) and DXY (green). On the lower panel we have included the 200 week correlation between the indexes, which is a fair measure of the long term relationship between these indexes. The length time period means that this indicator is slow to move, and its level reflects changes that have already taken place over a number of months, it also has considerable momentum once a change of direction takes place.

As can be seen this measure reached its peak (0.92) in the late 1990s when global flows were strongly in favor of US equities and remained positive during the 2000-3 bear market when many of these flows were reversed. The nadir came in early 2006 (-0.81), almost two years before the DXY itself made its ultimate low. As would be expected, the Eurocrisis created significant negative correlation (the DXY is dominated by the EUR and global equity markets were transfixed by the crisis) which caused the correlation to slip from -0.2 in early 2010 (on the eve of the crisis) to -0.77 in late 2011 as the LTRO was announced.

However, since the start of 2012 we have seen a persistently rising SPX index together with a stable to strengthening DXY index. This has taken the 200 week correlation up to -0.08, its highest level since March 2005 and it seems very likely that we will now move into positive territory. This strikes us as quite an important state of affairs, and it indicates that we may be about to see a considerable strengthening of the USD against not only major currencies but also a number of key emerging markets. Investors may be conditioned to see this as bad news for US equities, but if it is a reflection of much higher global flows into US equities (as was the case in the 1990s) it would actually be something of a benign strengthening, until the currency reaches a level in which export industries find themselves uncompetitive.

US Initial Claims data crossed a significant milestone this week with the 4 week ma of Claims falling below the key 350K level for the first time since March 2008. This is traditionally the point at which falling Initial Claims tend to be matched by a substantial ramp up in Non-Farm Payroll additions. Indeed the last time Claims fell below 350K after a prolonged period above this level was March 2004, and was followed by a blow-out Non-Farm Payroll report of 295K which marked the end of the "jobless" phase of that recovery.

This does not guarantee an exact replication this time around, and we would want to see Initial Claims remain below the 350K for a number of weeks in order to build confidence in the statistical improvement. Nevertheless the odds are growing that the senior employment statistics will deliver better than expected results in the coming months, perhaps starting with tomorrow's data. Even were tomorrow's February data to be a poor report (always a possibility given the BLS's methodology) it would not change the fact that the following months' numbers would be expected to be higher (indeed February 2004 saw a strangely weak 31K print which meant that the March report completely wrong-sided the market).

The ramification for fixed income markets are clear. To the extent that ultra-low yields are a result of generous monetary policy, which itself are driven by the FOMC's belief in intractable unemployment, the permanence of this state of affairs is increasingly open to question.

The SNB reported that its FX reserves at the end of February totaled 427.7 bln CHF. January's data was also revised higher from 427 bln to 429.5 bln CHF, meaning that although a modest cut in reserves took place last month, the total at the end of February is slightly higher than the initial level reported for January a month ago. In other words no real progress towards the trimming of the SNB's bloated reserves has taken place, despite the fact that the EUR/CHF cross has remained above the intervention rate of 1.20 for a number of months.

Given that the SNB have been following the "do whatever it takes" model of central banking, this reticence to unwind reserves is hardly surprising, particularly given the (over) reaction to the Italian election. However, it does firm our belief that the SNB will err on the side of doing "too much for too long", creating the risk of a runaway domestic real estate market in the process.

To a degree this has started to be recognized by the bond market and it is notable that although the Swiss yield curve remains abnormally depressed (see chart) the strange phenomenon of negative yields is now limited to the short end of the curve, with all maturities above 3 years having positive yields. Even so, the 10 year yield of 0.69% and 40 year yield of 1.22% hardly compensate investors for the risk that even a modest build up of inflationary pressures could take place in the coming quarters.

The ECB's balance sheet shrank by -€68.2 bln (2.95%) last week, mainly due to the second voluntary repayment of LTRO funds. This reduction takes the balance sheet (ex gold) down to €2,241 bln, the lowest level since February 2012. As would be expected much of this repayment came from the deposit facility which fell €22 bln to €144 bln. Excluding deposits and gold, the ECB balance sheet is currently €2,097 bln which is €318.3 bln larger than it was a year ago, but well below the peak level of €2,351 bln registered in August 2012.

Our view remains that so far the ECB's removal of liquidity has been benign, but that there is a risk that matters may deteriorate if the pace of liquidity withdrawal picks up. With this in mind we have been monitoring the Bloomberg Eurozone Financial Conditions Index (BFCIEU) quite closely and comparing this to the rapid fall by the US counterpart in 2010. Thus far Eurozone conditions remain in positive territory and the rapid deterioration that took place in early February fortunately stopped short of creating negative conditions. This breaks the similarity of the two patterns and while this does not guarantee that nothing bad happens later on, an exact re-run of the 2010 correction now looks rather less likely than it did two weeks ago.

One of the more sensible editorials written in the aftermath of Italy's election.

The news that additional restrictive measures would be placed in China's property market was poorly received by domestic equity markets, which clearly fear a return to the marked slowdown seen in late 2011 and 2012. The measures require cities with "excessively fast" price increases to raise down-payment requirements, and also warn sellers to "strictly" pay the 20% capital gains tax (a sign that hitherto this measure has been largely ignored).

In response to these measures, the SHASHR index dropped 3.65%, in the process breaching strong support created by the combination of the 50 day ma and the 2400 level. The Shanghai SE Property Index fell by 9.25% with 10 out of its 24 members approaching the 10% limit down for one day movements. This decline would seem to mark the end of the multi-month bear market rally, which ultimately failed to break out above strong resistance formed by the May 2012 peak.

The market's poor response would seem to be justified since this shift towards tighter policy strikes us an a significant development for China's rampant credit creation, which, thanks to its increasing reliance on shadow banking, has now moved further from regulatory control. Although the wish to temper asset inflation is understandable, measures that are effective enough to control real estate prices run the risk of bringing the asset cycle to a shuddering halt, with serious consequences for the collateral value of the myriad of financial products that have been issued in recent quarters.

The message from Beijing this weekend is that the authorities view rampant asset inflation as a greater danger than a downward spiral in credit quality. Paradoxically this means that investors now need to view the latter as the more likely outcome for the Chinese economy and financial system.

Even before the appointment of a new BOJ governor, it is clear that the central bank moved to implement a policy of rapid expansion of its monetary base. February's data shows a monthly increase in the seasonally adjusted base of 4 trln JPY, or 3.11%, which is the fastest monthly increase since April 2012 in percentage terms and November 2011 in nominal terms. This brings the annual rate of increase up to 15%, which is the fastest since January 2012.

Note that 13 months ago the monetary surge was in response to the earthquake and tsunami of March 2011 and was understood to be a temporary policy move that would be sterilized at a later date. Things this time around are very different with the BOJ embracing the Bernanke doctrine wholeheartedly. This has clearly already been understood by the local equity and FX markets, both of which have already priced in a substantial degree of quantitative easing in recent weeks. It remains to be seen how effective the policy will prove at the economic level but the sharp moves in markets was overdue given the levels reached in late 2012 and so can be expected to be sustained.

We were going to let the sequestration deadline pass without comment since as we have argued before (see our Media Trends piece from January 16th) Washington has received far too much attention from market participants in recent months, at the expense of things that matter far more such as corporate earnings. However, our attention was drawn to the accompanying data (calculated by Bloomberg ©) which shows the daily shift in Washington sentiment towards the risk of sequestration taking place.

This poll separates the opinion of the Administration (green), Congressional Democrats (blue), Congressional Republicans (red) and Business (black). It should be noted that Business has taken a correctly negative view since the start of the poll in late January, while the other constituents have shifted over time to a more pessimistic position. As of deadline day Business (-1.6), Democrats (-1.16) and Republicans (-1.85) are all "pessimistic" while the Administration (-0.65) is "inconclusive". Overall sentiment is at its most negative level since the poll was started.

The SPX on the other hand is modestly up for the day and has also modestly risen over the course of the poll. This is despite the attempts of the Administration to paint the most draconian scenario possible from what is ultimately a quite limited trimming of federal activity. It would appear likely that sequestration will take place against a collective yawn from the marketplace, with the future trajectory of the SPX much more likely to be influenced by a busy calendar of economic data than the horse-trading and stand-offs generated by a largely discredited political process.

Although most of Brazil's headlines are directed towards its poor Q4 GDP report (this showed 4 quarter growth of 0.9%), we are more interested in this afternoon's release in the February trade data, partly because it refers to a more recent period, but mostly because it continues a stark trend of deteriorating trade in a number of key emerging markets.

Brazil's February trade report showed an overall deficit of -$1,276, the second largest on record. This is something of a new condition for Brazil which has generally posted healthy trade surpluses since the start of the economic cycle a decade ago. Over the last 12 months the cumulative surplus has been $13,728, under half the level of February 2012 ($28,620) and unless the remainder of the year sees a rebound in export activity, Brazil may see itself generate a 12 month trade deficit later this year.

A decline in exports is the main cause of the deterioration, and these have fallen by -13.7% on a YoY basis. The 12 month average of exports is now just under $20.0 bln, the lowest level since July 2011. Imports on the other hand grew modestly over the same period. The decline in Brazil's export activity is of course one reason that overall growth has deteriorated, but it also has implications for overall liquidity within the Brazilian economy. This would now seem to be increasingly reliant on investment flows, and although Brazil's overall trade position remains far better than that of India or Turkey the pace of decline means that its impact will be felt.

The ISM Manufacturing report for February is a very solid set of data that suggests that the Manufacturing sector has started to re-accelerate at the start of 2013. There are several possible reasons for this, including a rebound from the slowdown caused by Superstorm Sandy and indecision caused by the Fiscal Cliff debacle (it is notable that sequestration has largely been ignored by both the market and industrialists). However, the impact of a strengthening housing sector should not be underestimated, and this can be expected to have a sizable beneficial impact on activity as the key spring selling and construction season get underway.

In terms of the data itself the overall index rose to 54.2, the strongest reading since June 2011. Most importantly New Orders (red) were very strong at 57.8 and this was reflected by robust Production at 57.6. The strength of future activity was further helped by a surge in the Order Backlog index to 55 (see separate chart), its highest level since April 2011 (we believe this reflects the impact of the Sandy and Fiscal Cliff rebounds). Overall Inventory (olive) levels experienced a modest rebound at 51.5 and Employment expanded modestly at 52.6. It addition to the strength of the data, the breadth was also impressive, with almost all the separate industries showing positive growth.

In short this report really underlines the fact that the US industrial sector remains in fine shape, and suggests that Q1 earnings can be expected to meet or beat expectations.

The BEA estimation of Personal Income for January showed a sharp drop of -3.62%, greater than the expected draw-down of -2.4%. No doubt this will drive much commentary this morning, but the sharp contraction is largely a result of the overstatement of income last month, when the data showed an inexplicable single month rise of 2.6% (unrevised in today's release). A portion of the January draw-down will also have been caused by the increase in payroll tax at the start of the year. Even after January's sharp draw-down both Personal Income and Personal Income after Household Financial Obligations remain in their gentle but persistent up-trends.

Although the increase in payroll tax may have an impact on the most marginal household incomes, in most cases the effect is likely to be felt more on a slight reduction of savings or a modest uptick in credit usage than on a moderation of consumption. Certainly January's retail data showed little cause for concern and we will have much more insight into February's activity by Monday morning, when most retail and automobile sales data will have been released.