Brazil continues to see its fiscal position erode as slower economic growth and more aggressive fiscal stimulus move the country deeper into deficit. April is seasonally a strong month for the fiscal balance. The PRimary Budget Balance (which does not include interest payments) was expected to be 13 bln BRL but instead came in at a weak 10.3 bln, which is the lowest April surplus since 2004. This led to a Nominal Balance of -7.67 bln BRL which is the widest deficit ever seen in any April on record and compares with a deficit of -4.7 bln BRL in April 2012. The trailing 12 month ma has fallen to -11.03 bln BRL, the lowest since October 2009 and we would expect to see wider deficits moving forwards, particularly since local currency and USD interest rates now seem to be moving higher, and the BRL lower, making future debt service more expensive.

As a percentage of GDP the deficit remains manageable at -2.92%, but it seems likely that the psychologically important 3% level will be crossed sometime this summer. Although we doubt the depths of 2003 when the deficit reached -6% will be reached, the pricing of Brazil's external debt is vastly more aggressive today than it was a decade ago. We therefore see further room for downside in Brazil's bonds going forwards.

Our decision to pay close attention to the EM high carry currency arena proved to be correct since recent days have seen growing signs of dislocation with the ZAR reaching 10.13 (up from 8.96 on April 30th), the INR 56.50 (53.8), BRL 2.125 (2.00) and TRY 1.87 (1.79). Thus far only the ZAR can be said to have truly broken down but any follow through in selling pressure next week would have the potential to wreak some havoc in this area (see chart).

Perhaps the most important thing to understand is that this sudden weakening of currencies reflects FX markets moving closer to the fundamental economic data rather than a reflexive market panic driven by a general risk off environment (as was arguably the case with the 2011 sell off). Recent months have seen a persistent worsening of trade and fiscal deficits in this group and the stability of the underlying currencies was only an illusion created by persistent and strong foreign investor demand for local bonds and equities.

This morning's publication of Turkey's trade data was a useful reminder of this fact, with the deficit ballooning to -$10.3 bln, well above consensus of -7.8 bln and the second highest deficit on record. Turkey's deficit has been recovering in recent quarters after having reached a 12 month average of -$8.8 bln in late 2011 but it would appear that this process of recovery has run its course and after reaching -$6.92 bln in December 2012 the average has now fallen back to -$7.34 bln. Without strong investor flows a deficit of this magnitude is incompatible with a stable currency. The danger is growing that the recent poor performance of local bonds and equities will disrupt investor flows, leading to a nasty feedback loop into the currencies value. We very much doubt the trade deficit itself can be turned around in the short to medium term, making a sharp adjustment of currency the most likely (and frankly the most traditional) manner in which this process will unfold.

Last night saw a broad slew of Japanese economic data published most of which suggests that a modest acceleration of activity is starting to take hold. April Industrial Production increased by 1.7% MoM compared to expectations of a 0.6% gain while March's strong 0.9% print was left unrevised. This means that although Industrial Production continues to be negative on a YoY basis (-2.3% in the non seasonally adjusted series and -3.4% in seasonally adjusted) this reflects the sharp slowdown that took place last spring and early summer rather than the steady rebound which has now taken hold. Overall production remains low at 91.5 (2005 = 100) suggesting that there is plenty of capacity for accelerated gains going forwards.

Housing data has shown a slow but persistent recovery for a number of quarters and April continued this trend with Annualized housing starts rising to 939K, beating consensus of 924K and up from March's 904K print. This is the highest level of activity since July 2009 and represents a gain of 5.8% YoY. Pre-crisis activity levels ran around 1200K again allowing for significant acceleration going forwards.

Finally employment data was also encouraging. The Unemployment rate remained at 4.1% (a reminder that this is one area in which Japan leads the developed world) but the ratio of Job Openings to Applicants rose to 0.89, the highest level since July 2008, again suggesting some improvement in the demand for labor.

The April 2013 Pending Home Sales report follows the familiar pattern of decent headline data and very strong non-seasonally adjusted data underlining the fact that 2013 has seen the re-emergence of traditional strong spring selling season which has very important implications for the aggregate activity for 2013 as a whole.

The headline index rose slightly from 105.7 to 106 (2001=100), which is the highest reading since the April 2010 report when tax credits were in effect. Ignoring this period you would have to go back to February 2007 to find a higher number, which of course was the eve of the sub-prime collapse. However, February was a wintertime report when seasonal adjustments strongly favor the headline index. For a true picture of the underlying strength of the housing market we must look at the NSA data which rose sharply from 122.1 in March to 128.6 in April. Ignoring April 2010 this is the highest reading since April 2006 which was also 128.6 and is only bettered by the April reports for 2004 (140.2) and 2005 (147.4).

This suggests that the current springtime season is running at a pace of activity unseen since the days of the housing boom, something that is not currently reflected in the sales data of either existing or new homes. Although we suspect that Pending Sales may exaggerate the strength of the market we suspect that sales data may still start to accelerate appreciably (particularly new home sales) in the coming months as Pending Sales transition into completions.

Since we were traveling when Q1 GDP was originally published we never issued a comment on the data and so we will use this morning's publication of minor revisions to redress this. Overall GDP was estimated to have risen by an annualized rate of 2.4% in Q1, down slightly from the original estimate of 2.5%. This continues the long series of tepid but positive reports and on the surface would give little support to the very strong equity market gains being made in recent months.

However, it needs to be remembered that GDP is by definition a "catch all" measure. When the various parts of the economy are growing or shrinking in a synchronous fashion this is not a problem but should a significant divergence between the government, corporate and personal sectors take place, then the headline GDP figure becomes essentially useless at measuring economic growth in the individual portions of the economy. This is of course the case at present and the Q1 GDP report shows strong growth in most private sector reports with the key Personal Consumption growing 3.4%, Equipment and Software by 4.6% and Real Estate by a handy 12.1% in "real" terms. Meanwhile Federal spending shrank by an estimated -4.9% and Defense by -12.1% (see chart).

While this negative force from the last two areas will have had some impact on corporate earnings (particularly in corporations with a heavy government bias) it strikes us as much less important than the strong growth in the other three portions of the report. We would therefore argue that the "corporate opportunity" described by this report is substantially higher than the headline number would suggest, making this a much more "normal" recovery for the private sector than most economists realize.

One of the most dangerous combinations for investors are worsening economic conditions coupled with a central bank that feels the need to underline its hawkish credentials. We saw the effects of this in Europe during the summer of 2008 and Spring 2011 when the ECB foolishly chose to raise the Main Refinance Rate at a time of growing financial stress and also in the period between the Bear Stearns and Lehman collapse when the FRB slashed its holdings of Treasuries in order to sterilize the emergency injections of liquidity being made via the TALF and PDLF. In each case policy was reversed within a matter of months and followed by much more significant loosening measures than seemed possible at the time that the decision to tighten was taken.

The decision to reverse almost two years of rate cuts in Brazil was taken in April with the SELIC being increased to 7.25%. At that time it was indicated that a further increase or two could be anticipated and the market prepared itself for a 25 bp increase in May. Instead an increase of 50 bp was delivered, which we suspect was partly in response to a sudden weakening of the BRL which fell from 2 to 2.11 over the last couple of weeks.

Unfortunately we doubt that last night's decision will help the currency or rebuild the tattered reputation of the central bank, which had been accused of being overly influenced by political pressure during the rate cut cycle. Brazil is in the midst of a significant downturn and arguably needs looser not tighter monetary policy at the current time. We expect this to be realized by capital markets sooner than by the central bank and would be watching Brazilian equity, bond and currency prices closely in the days ahead.

Although most of the attention yesterday was drawn towards the nasty sell off in US Treasuries, there was actually far more substantial damage sustained the emerging market credit complex. We highlighted the poor performance of EM local currency bonds yesterday and today we will look at the high quality USD bond market which has suffered its second sharp leg down of 2013.

Attached is a chart showing the performance of 4 widely held sovereign credits (Philippine, Brazil, Peru and Panama) with maturities between 2031 and 2037 and each of which is a member of the JPM EM USD bond index (JPEICORE). We have also included a line showing shares outstanding in the EMB ETF, which is a $5.6 bln ETF that tracks the index and thus represents a rough proxy for investor flows into the complex.

As we pointed out several months ago, this area of capital markets became extremely crowded and overpriced at the end of 2012 and we tracked a steady withdrawal of capital in the early weeks of 2013. This bout of profit taking then subsided allowing the underlying bonds to recover a portion of their losses. However, since early May a second wave of selling has taken hold which has taken the complex back down below the levels reached in the earlier sell off. The JPEICORE index is now down -2.41% while the EMB ETF has lost -4.23% (total return), although both still enjoy healthy gains over a 12 month time period (thanks to strong 2012 performance).

Interestingly there is far less evidence of capital withdrawal from the EMB ETF in May than earlier this year. Shares outstanding have only fallen by 1000 (2%) since the end of April compared to declines of 1,800 (-3.2%), 2,400 (-4.4%) and 3,700 (7.1%) in January, February and March. This suggests that the underlying market has weakened considerably in recent weeks even though US investors have remained patient with their investments.

We have always considered this area to be potentially vulnerable to any sustained back up in treasury yields and it is starting to appear that our fears have been well founded. Should US treasury yields continue to push higher the scope for considerable losses in more esoteric credit markets should not be underestimated given that many lack the sort of deep liquidity in their secondary markets needed to absorb substantial redemption pressure.

It is starting to look as if the long refi boom that started with "Eurocrisis II" last May and was extended by the introduction of QE3 has run its course. Even before yesterday's spike higher in long dated treasury yields the MBA Refinance index was faltering with the Application Index for the week ending May 24th falling to 3723.30, which (excluding the very low Christmas week abberation) was the lowest reading since the current boom started in late April 2012. Although the Memorial Day holiday may have had some effect, the index has been declining for several weeks as Treasuries and the fixed 30 year mortgage rate have climbed higher. Barring a sudden reversal in long dated yields we would expect to see another sharp decline in applications this week with a reading below 3,500 marking the close to the current refinance boom.

As we have discussed before ends of booms typically occur during periods in which yields are rising but they also feed into this process, since a reduction in refinance activity causes a significant slippage in demand for long dated treasuries by MBS holders seeking to hedge duration risk in their portfolios. We would therefore argue that the refinance cycle has now started to turn against the Treasury market after having been a source of considerable incremental demand over the last 13 months. This is bad news for bondholders already nursing YTD losses across broad swathes of fixed income holdings.

With regards to the overall housing market we would expect that rising long term yields will cause rather less disruption. This is because although the traditional 30 year mortgage could rise to the point that it becomes an unattractive or unaffordable option the alternative 5/1 Year ARM product (or a variation on this) is much less likely to move sharply higher since it is linked to the short end of the curve which the FOMC is likes to keep at an ultra low level.

Currently the 30 year mortgage rate is 3.88% and the 5/1 Year ARM 2.69%, a fairly significant spread that would normally see much more than 5.4% of mortgage applications seek a variable rate mortgage (see chart). Should the 30 year mortgage rate start to move up through the 4.00% level or higher we would expect to see substantially more activity take place in adjustable rate products, thus allowing the current housing cycled to continue to strengthen in the months ahead.

May's Conference Board Consumer Confidence report is the latest piece of data to suggest that recent months have seen a significant strengthening of the US economic cycle and we are unsurprised that the strong rebound in housing together with the breakout by the SPX index to all time highs generated a substantial upside surprise in the index.

Overall Confidence rose to 76.2 (1985 responses = 100), well above expectations of 71.2 and the strongest report since February 2008. More interestingly the Present Situation report led the breakout, rather than Expectations. The Present Situation index rose to 66.70, its highest level since May 2008 while Expectations remained range-bound at 82.40 (this much more volatile index has been between 50 in October 2011 and 97.50 in February 2011 over the last three years). This suggests that the audience was responding to an appreciable change in actual circumstances rather than some nebulous hope for the future. As can be seen on the attached chart, the Present Situation index tends to trend powerfully and has historically been closely linked to the direction of local US monetary policy (using the FDTR to define the latter). This is hardly surprising since both consumers and the FOMC respond to similar data inputs and although neither has been shown to be particularly prescient at the great turning points of cycles they have both generally responded accurately to upside and downside acceleration of trends.

We therefore would view the breakout of consumer confidence as another signal that the FOMC's current bond purchasing program is at risk of ending sooner than most observers expect, although we doubt that the FDTR will be touched for a considerable period of time.

The China Business Cycle Index is jointly produced by the National Bureau of Statistics and Goldman Sachs. While we have no sense as to its true degree of accuracy, it does at least fluctuate over the course of a cycle making it rather more useful than many of China's other largely "static" economic reports. The index is centered around 100, becoming "Hot" above 116.7 and "Very Hot" above 136.7. "Stable" conditions are denoted by readings between 83.3 and 116.7", "Cold" below 83.3 and "Very Cold" below 63.3.

April's report saw the index fall from 93.3 to 89.3. Although this keeps the index planted in Stable territory it is interesting to note that the massive acceleration of credit granting over the last 15 months has not led to any appreciable pick up in this index, with April's reading being only slightly higher than the 87.30 reading of a year ago. Our growing belief is that outside of real estate and infrastructure construction conditions within the Chinese economy have weakened substantially in recent months and that any attempt to rein in credit granting will serve to restrict the one remaining engine of growth for the current cycle.

We continue to witness a steady erosion of the value of most EM high carry currencies with weakness being led by the ZAR which this morning fell to a 4 year low of 9.747 against the USD. This morning's weakness was apparently caused by a poor GDP report with Q1 2013 growth falling to 0.9%, well below the 1.6% rate which had been expected. Thus far the damage has been wrought by a series of baby steps but the danger is growing that an accelerated liquidation will take place later this quarter.

As would be expected, there are increased signs that the ZAR's sell off is weakening other high carry currencies with the INR testing key resistance at 56 this morning. Should this level break a full retest of last June's record at 57.32 can be expected to take place. Given the extreme popularity of Indian equities and bonds in 2013, a breakdown of the local currency would presumably come as something of a surprise to most investors.

The other two currencies we are tracking held up a little better in recent days. The TRY continues to flirt with resistance between 1.85 and 1.86, above which a move up to the June 2012 peak at 1.878 could be expected. The January 2012 record of 1.922 would be a realistic target if the June peak was exceeded. The BRL has been following a more moderate path in recent weeks, but it has still managed to push up above the 2.05 level and now can be expected to move up to 2.10 during any further weakness. We would expect to see fairly aggressive intervention by the Bank of Brazil should this take place.

As would be expected the sharp loss of currencies has taken a toll on emerging market local currency bond returns. The JBIEMCOR index (which tracks EM local currency government bonds) had offered a rare glimpse of positive returns for fixed income, with the index gaining over 4% for the year in early May. These gains have now been erased and the index is now returning 0.37% for the year meaning any further erosion of currencies or underlying bond prices will push the index into negative territory.

Although emerging market currencies and bonds experienced bout of turbulence before, these have generally come during periods of global "de-risking". The current episode is taking place during one of the strongest first half years on record for developed equity markets making it a much more interesting event to follow.

Brazil's monthly loan data continues to show a marked divergence between credit granting by the Private Sector banks which has slowed to a crawl pace of 6.3% annual growth and the Public Sector which has increased loans outstanding by over 29%. Total Private Sector loans for April increased by 1 bln BRL to 1,246 bln while Public Sector loans increased by 25.2 bln (2.14%) to 1,206 bln, which suggests that by mid summer the latter will represent the majority of loans outstanding. As we have argued before the lateness of the cycle and the fact that Private Sector banks seem unwilling to advance new credit suggests that the growth of Public Sector lending is being driven by political pressure and has resulted in a substantial reduction in underwriting standards.

Within the various sub categories Housing credit (grey) continues to dominate with 8.1 bln of new loans (2.5%) and this category has grown over 33% over the last year. Housing now accounts for 13% of total loans up from 5% in 2009. We also note that Government loans (orange) has also recently been rising sharply with April's total increasing by 3.7 bln 125 bln.

Personal credit (red) grew by 7.2 bln (1%) and has grown by just over 9% over the last 12 months. Delinquency levels for Personal loans fell slightly to 7.5% from 7.6% keeping in place the modest improvement seen since underwriting standards for automobile loans were tightened last year. However, we remain concerned that any deterioration in employment will lead to a sharp increase in delinquency rates and still regard this as a meaningful risk going forwards.

Perhaps the most interesting and challenging aspect about the current global investment environment is that there is an unusually wide dispersion of where various regions are in their business and investment cycles. This is a significant change from the state of the world 5 years ago when the emerging market "de-coupling" thesis fell apart in the synchronized global swoon, with an equally widespread recovery following in 2009. Since late 2010 however there has been an increasingly marked divergence of economic and market behavior although it has arguably taken until this year for this to actually be commented upon or influence investor allocations.

One way to visualize this is by looking at consumer confidence and market action and since Italy and Brazil both published their respective survey results this morning we will compare these two countries who find themselves at opposite ends of their investment cycles. Italy we would argue is hopefully at the start of a meaningful recovery after the traumatic experience of the Eurocrisis. As is typical consumer confidence remains extremely low and has shown no recognition of the progress that has been made over the last 18 months. May's reading of 85.9 keeps confidence pinned in the range which has contained it since last Spring and it would take a move above 90 to really suggest that consumers' moods are changing. Of course this does not mean that the local equity market will remain moribund and the FTSEMIB index has risen 40% from its July 2012 low. The index is currently range-bound between 15,000 and 18,000 and we would expect a break above the latter to precede any significant improvement in confidence.

Brazil on the other hand combines relatively high but declining confidence with poor equity market performance. The local confidence index fell to 113.40 from 113.90 this month down from its 2012 peak of 128.70 when the promise of fiscal and monetary stimulus caused a surge of confidence. The IBOV index remains in its two year old bear market with the index failing to make progress in 2012 and at the current value of 56,349 -23% below its November 2010 peak in local terms and -38% in USD terms. In Brazil's case we continue expect to see further drops in both equity markets and consumer confidence before this down cycle has run its course.

The New York Federal Reserve Bank issued its latest economic forecast this morning:

http://libertystreeteconomics.newyorkfed.org/2013/05/just-released-the-new-york-fed-staff-forecastmay-2013.html

It is interesting to note that this contains a forecast that the Unemployment Rate will fall to 7.25% by Q4 2013 and 6.50% in Q4 2014. This is substantially sooner than the late 2015 guidance that the FOMC issued for a 6.50% Unemployment Rate at the time the decision to undertake QE3 was made last year and has continued to use in recent public guidance. This represents the first hard evidence that a string of better than expected data is starting to shift economic forecasts within the FRB system, which given the now explicit linkage between data and policy has obvious implications for monetary policy going forwards. Late 2014 still seems unduly pessimistic to our eyes, since we think it is likely that a strengthening economy can reach this target 6 to 9 months earlier but the shift in timing by the key NY Federal reserve is likely to be an important step in changing the overall guidance of the FOMC.

Census Bureau estimates of US New Home Sales took a substantial step towards recognizing the strength of the housing market (already reflected in the actual sales data from public homebuilders) with April sales estimated at 454K (425K consensus) and March sales revised strongly higher to 454K from 417K. Large positive revisions are starting to become a feature of the data with the last 5 reports being revised higher by an average of 23K. This means that sales have increased by almost 29% over the last 12 months and that the trailing 12 month ma has breached 400K for the first time since April 2009.

There is growing evidence that builders are starting to respond to rising sales since although inventory remains very low at 156K this is a rise of 6K from last month, which is the largest monthly increase since June 2006 (when the inventory was a bloated 570K). As would be expected inventory gains are now led by the "Under Construction" and "Not Started" categories (both up 4K) while "Completed" homes actually saw a small drop in inventory. In other words builders are starting to construct "spec" housing in anticipation of better demand, another sign that the cycle is accelerating.

Again as would be expected prices showed a strong increase (see today's note on FHFA data), with the Average price of a home sold reaching a record $271.6K. It is hard to reconcile this with other data which show national prices still well below their 2007 peak but the Census Bureau may be picking up a substantial shift in product mix since mid to high end new home demand seems to be recovering much faster than the low end. However the notion that prices are now rising quickly is one we agree with.

One final chart with considering is our long standing comparison of the pace of New Car, Existing Home and New Home sales in the US. Back in late 2011 we made the case that the divergence of the New Home market from the other two key areas of consumer activity was not sustainable. Since this time New Home sales have recovered from roughly 25% to 43% of their level in December 2001 (our definition of a "normal" time period for these metrics), but this still massively lads the level seen in Existing Homes (83% of December 2001) and New Car sales (84.5%). We would expect to see this yawning gap closed rapidly in the months ahead, implying a further sharp acceleration in the pace of activity in the New Home market.

The bulk of data continues to suggest a very robust housing recovery has taken hold in the US with rising demand and tight inventories leading to substantial rises in national property prices. The March FHFA report, which tracks housing transactions eligible for GSE mortgages, was released this morning and this showed a rise of 1.3%, the largest single month rise in the 22 year history of the index. Regional dispersion ranged from a frothy 2.3% in the Pacific to a healthy 0.6% in New England.

This takes the National index back up to 199.1 (up 7.2% YoY) its highest level since February 2009 and equivalent to the price level seen in late November 2004 just before the final blow off rally in prices to the all time high of 227.3 in April 2007. This underlines the fact that an increasing number of homes purchased or refinanced during the great housing boom are now back "above water". In our experience rising prices act as a strong accelerator for demand of housing (at least until affordability becomes an issue) and with the supply of existing homes remaining tight (yesterday's data showed April's inventory was back to 1999's level) it seems clear that a substantial construction cycle for new homes is likely to unfold.

Last week's surge in Initial Claims data appears to have been a data-blip and this morning's report showed Claims falling back to 340K, a little better than the 345K anticipated. This caused the 4 week ma of Claims to tick slightly lower to 339.5K, keeping this metric well below the key 350K level. Given the tough seasonal adjustments present at the current time of year this is more of an achievement than might be apparent. NSA Claims were estimated at 301.1K, the best reading for mid-May since 2007 and the 3rd lowest reading for any week since October 2007.

This improvement was also registered in the Continuing Claims data, which fell sharply to 2,912K and is now comfortably below the key 3,000K for the first time since April 2008. Although this data-set suffers from the fact that long term unemployed are eliminated regardless of whether they have found a new job we have generally found it to be a useful trend indicator for overall employment conditions.

It was perhaps appropriate that at the same time that the FRB Chairman commenced his robust defense of the Bernanke Doctrine the NAR released its estimate of April activity in the existing home market. This showed a continued pace of sales just below the 5mm level confirming that the winter surge in activity was no seasonal fluke but was a genuine turning point in cyclical demand.

Overall sales were estimated at 4.97mm units, just below consensus of 4.99mm while March was revised slightly higher to 4.49mm homes. This represents an increase in activity of 9.7% from a year ago and means that activity has reached a level which is equivalent to the normal years at the end of the last century. Condominium sales continue to grow faster than the overall market at 15.7% and at 590K are now back to the level seen in April 2002 at the start of the housing boom.

The strong spring selling season has led to a robust increase in listings with single family home inventory rising to 1.92mm homes. Although this is 230K higher than March this represents a normal seasonal pattern that had been largely absent in the crisis years and 1.92mm is still the lowest April inventory seen since 1999, underlining the extent to which inventory has been absorbed in recent months. The tightening of the housing market can be seen in prices as well, with the average price paid increasing to $243K a 9.3% increase from April 2012. NAR prices tend to be highly seasonal but the trend of the 12 month ma suggests that house price appreciation is starting to be an increasingly important factor for the current cycle.

Brazil's Current Account (CA) continues to deteriorate significantly with April's data showing a -$8.3 bln deficit, somewhat wider than expectations of -$7.2 bln. This compares to a CA deficit of -$5.3 bln in April 2012 and is the 9th month out of the last 12 to show a YoY deterioration. This takes the 12 month ma of the CA deficit to -$5.8 bln, a new record and a sizable increase from the -$4.3 bln level of a year ago.

Although FDI has remained stable over this period, reaching $5.7 bln in April and averaging $5.3 bln over the last 12 months, the deterioration in the CA means that FDI is no longer sufficient to cover the CA deficit, with the 12 month difference between cumulative CA and FDI now $5.9 bln. It should be noted that the massive PBR bond offering that took place in May will lead to a spike in FDI (as took place in December 2010) but this would not disguise the clear trend towards a funding deficit even at a time when Brazil remains an attractive destination of foreign capital.

We continue to see growing turbulence in currency markets, which have never regained their poise since the BoJ's radical change in monetary policy led to the sharp devaluation of the JPY. This disruption plus a general theme of post-crisis repair has started to erode the rampant demand for the Swiss franc (CHF), which has recently lost considerable ground against a strengthening USD and is now starting to slip against the EUR with the EUR/CHF cross breaching 1.26 CHF for the first time since May 2011. Thus for the first time since the 1.20 floor was put in place, it has become irrelevant for market activity.

The same is not true of the SNB itself, since a major influence behind today's breakout was the suggestion by SNB President Thomas Jordan that the floor could conceivably be adjusted higher should the SNB wish to inject more liquidity into the system. This comment comes as something of a surprise since most observers would have expected the SNB to welcome the strength of the Euro as allowing a much needed pause, or even reversal, in the massive buildup of SNB reserves which seem increasingly likely to spur domestic asset price inflation.

Then again, as we have seen with the FRB's embrace of the Bernanke Doctrine, the targeting of economic growth (or employment) by a central bank leads to a stubborn determination to stay involved in capital markets long after the original goal of crisis intervention has been achieved. The implications for the CHF are that its status as a safe haven currency are currently overestimated, which in turn suggests that Swiss long term bonds are significantly less attractive (versus other developed economy sovereigns) than their substantial yield discount would imply.

It is really too soon to expect the sharp devaluation of the JPY to have started to show up in export data and therefore we were unsurprised to see only a modest YoY bounce of 3.8% reported in Japan's April trade report. Post crisis Japan's monthly exports have hovered around the ¥5.4 trln level, compared to their 2008 peak of over ¥7 trln, while imports have recovered to an average of ¥6 trln over the last 12 months, or almost 90% of their 2008 peak. This has created a trade deficit that has averaged ¥704 bln over the last 12 months, which although comfortable when compared to the size of the overall economy, is still a very unusual state of affairs for Japan.

The big question now is the extent to which currency competitiveness can lead to a recovery of the roughly ¥1.5 trln of exports lost in the financial crisis, and a big part of this will be the regeneration of demand for goods in Japan's key export markets. In this regard it is interesting to note that the US has once more become the largest export market for Japan after losing this position to China from 2009 - 2012 (see chart). Exports to the US appear to be growing significantly faster than overall exports, with April posting a 14.8% YoY gain and a trailing 12 month average gain of 9.8%. Exports to China on the other hand have fallen by an average of -8.1% over the last 12 months as a combination of slower Chinese growth and political tension have damaged a key bilateral trading relationship.

All the evidence suggests, a great deal of flux between the awkward triangle of US, Chinese and Japanese relations in the months ahead with the political and economic spheres likely to overspill into each others' territory to an unusual degree. The possibility of a reinvigorated Japan emerging at the same time that China confronts its own tragically imbalanced economy is one that should not be ignored at the current time.

With the May data cycle winding down and Chairman Bernanke due to testify tomorrow, it makes sense to look at the state of the US yield curve and think about what changes may take place in the weeks ahead.

QE 3 is now over 6 months old, a period of time which has seen generally robust economic data and a distinct improvement in employment statistics some of which (most clearly Initial Claims) are now approaching normal levels for economic expansion while others have improved substantially but remain at problematic levels (Unemployment being the most important example).

At the same time a strong recovery in the US housing market has been established and although activity levels remain below average at the national level, a number of important regional markets appear to have re-entered housing booms. On top of this the US equity market has broken out into blue-sky territory while the strength of the USD suggests that the US is becoming a destination for global investment capital to a degree unseen in over a decade.

It is fair to say that very little if any of the above was considered likely by Chairman Bernanke at the time he penned his Jackson Hole speech last August, and certainly none of the late 2012 FOMC minutes contain a sense that its members had a sense of what lay around the corner. Nevertheless the chance of this week's testimony hinting at a major reassessment of FRB policy seems to be remote since policy remains tethered to the Unemployment rate which remains well above the 6.50% target at the current time. We would therefore expect to see the Chairman use cautiously optimistic language in his speech and answers, aiming to keep options open for future tweaks to policy.

This sense of policy certainty is reflected in the current yield curve which has remained largely unchanged since the middle of 2012 maintaining a somewhat unusual shape over this period of time whereby the front end of the curve remains extremely shallow while the back end of the curve is much steeper. This can be seen on the attached chart which slices the overall curve into 4 segments: 1 to 2 years (blue), 2 to 5 years (green), 5 to 10 years (purple) and 10 to 30 years (black).

Prior to QE3 we have referred to the first two being set in the "public sector" since they are heavily influenced by FOMC rate policy while the last two are much more under control of the secondary market for notes and bonds. Of course QE3 somewhat clouded this distinction since it involved direct purchases by the FRB at the long end of the curve but we believe that it still largely holds intact. It therefore makes sense to really concentrate on changes at the long end of the curve since this still has the potential to move sharply even if the FOMC chooses to keep purchasing securities over the course of the summer.

The 5 to 10 year spread is currently 111.5 bp, putting it roughly in the middle of its 3 year range which has been as high as 149 bp in July 2011, as QE2 wound down and the Debt Ceiling debate pushed yields higher, and as low a 83 bp in June 2012 (when the 10 year note fell to a record low yield at the end of the Eurocrisis). A move above 120 bp would to our eyes signal the start of something interesting in this portion of the curve.

At the long end the 10 to 30 year spread has been extremely steady around the 120 bp level over the last 9 months. This is somewhat unusual given the historical volatility of this relationship and may in fact be a direct result of FRB intervention. Over the last 3 years the spread has been as high as 159 bp in November 2010 when the start of QE2 distorted the middle of the curve and as low as 94 bp in October 2011 when Operation Twist was all the rage. Given the suspiciously tight relationship between 10 and 30 year yields, we would pay attention to any spike that takes the spread much above the 125 level, and in fact this may end up being the purest indicator of the bond markets willingness to go along with the current FOMC policy in the face of numerous data points that suggest it has outstayed its welcome.

We continue to observe an erosion in the value of EM high carry currencies with weakness now visible in all 4 currencies that we track. The ZAR (green) continues to lead the way lower with its spot rate against the USD hitting a new 4 year high of 9.62 this morning before recovering a little to 9.54 (this compares to its value of 8.47 at the start of the year).

The TRY (red) has been the second weakest currency in recent sessions with its spot rate now above 1.85 for the first time since June 2012 when the rate peaked at 1.877, which now looks to be a reasonable short term target. Above this level is the January 2012 record at 1.922, or around 3.8% away from the current level.

Perhaps most surprisingly, given the persistent massive capital flows, has been the sudden weakening of the INR (orange) which saw its spot rate break through 55 yesterday and rise to 55.42 this morning. This brings key resistance at 56 into play and above this lies the record spot rate of 57.32 recorded last June.

Compared to the other three currencies the BRL (blue) remains fairly solid, but recent sessions have still seen the spot rate rise from 2 to 2.04. Strong resistance remains intact at 2.05 (where the currency started 2013) but a breach of this level would indicate a rapid move back up to 2.10.

One of the relationships that we have kept a continuous eye on since the start of the current bull market is that between the SPX and the DXY indexes. It is easy to forget that 5 years ago many investors questioned the sustainability of the USD as a reserve currency just before its "safe haven" characteristics were to be amply displayed during the financial crisis.

Although the DXY index's progression has been sedate it has made steady progress over the last few years, and over the last 18 months has really shed its mantle as a "safe haven" currency that only makes progress during times of global stress. Most notable has been the currency's continued modest advance in 2012 and 2013 despite this period being one which has been solidly "risk on", with the SPX rising from 1257 to 1669 (32%) since the end of 2011 and the DXY has gained over 4% YTD. Most notably the breakout of the SPX to 1666 on Friday afternoon (1000 points above its March 2009 low) accompanied by a breakout by the DXY to its highest level since July 2010.

The effect of this has been to push the long term correlation (200 weeks) between the SPX and DXY index back into positive territory for the first time since the 2003-5 period (the initial stage of the 2003-7 bull market was warmly embraced by global investors before they switched their attention to emerging markets at the US's expense). This suggests that foreign capital flows are starting to be attracted to the US equity market in a manner that has not been seen since the great technology bull market and we would expect to see a strong correlation between US equities and the DXY index continue in the months ahead, although we would expect the cumulative gains by the USD to be somewhat less than what took place in the 1990's. This clearly has important and positive ramifications for the remainder of the equity bull market which should be able to benefit considerably from global financial flows for the remainder of its life-time.

Given the massive expansion of non-bank credit seen in recent months it comes as little surprise to see buoyant price data for Chinese Real Estate being released in April. The national survey of 70 cities showed increases recorded in 64 and decreases in just 6 which puts the market back to where it was in the summer of 2011.

Two years ago the PBOC was in the midst of its "macro-prudential" experiment, which briefly succeeded in bringing order to China's runaway real estate sector but was undermined by weakness in other portions of the economy and the PBOC's concerns about the potential for a collapse of European demand for Chinese goods. Since early 2012 the PBOC has allowed a modest loosening of monetary policy, but this has been less important that the massive increase in non-bank credit issuance that ironically was influenced by attempts to restrict the banking sector.

The problem for the PBOC is that while in 2010 the Real Estate sector was an important part of China's economy, it now appears to be the only portion capable of generating national growth close to the stated targets of the administration since the strength of the export driven industrial sector seems much more questionable today than it was two or three years ago (and this is before the full effects of the JPY devaluation have been felt). At the same time, it is starting to dominate capital flows and credit issuance in a manner that is reminiscent of all the great credit bubbles that litter financial history. We are yet to see any genuine determination to restrict total credit issuance in China, or perhaps more accurately for such determination to translate into an actual slowdown in issuance. We would expect to see this change later in 2013, since we doubt that the PBOC will be willing to see its desire for moderation ignored for too much longer, but the longer things stay as they are the greater the eventual disruption once the cycle ends.

An excerpt from this morning's interview - discusses developed equity markets and fixed income.

www.bloomberg.com/video/tragedy-of-trillions-put-into-fixed-income-shaoul-FpLO9TRJR2C_1ls7lGG2VA.html

Since breaking its key support at $1520 in mid April gold has followed a classic bear market script, almost exactly matching our expectations for support ($1,321 vs $1,300), the degree of recovery ($1,488 vs $1,500) and the length of time taken for a re-test of support (not long). This does not mean that we are particularly insightful, but more that gold is following its most obvious technical pattern, which in turn suggests that more technically minded (ie institutional) investors are currently in the driving seat.

Indeed that last few weeks would appear to have been a straightforward result of competing institutional and retail flows. The breach of $1,520 was caused by persistent liquidation of global ETF holdings with the Hedge Fund heavy GLD ETF pushing the metal's price lower. The failure of support to hold led to a sudden rush of stop-loss related selling, while support at $1,300 signaled a change to a bargain hunting mentality which was whole-heartedly embraced by global retail investors. This was clear by the myriad of news stories describing the spike in global coin sales (see chart) together with the outrageous language used on many message boards.

Unfortunately retail demand tends to be sharp but fleeting, since this pool of capital has the tendency to be limited and quickly expended. Conversely an institutional change in allocation policy (which would appear to be taking place with gold) takes a great degree of time to unfold and involves a massive amount of capital. Thus after the sharp late April bounce the balance of power between retail buyers and institutional sellers shifted steadily to the latter leading to another period of sharp losses for gold which we are in the middle of at the current time (see annotated chart).

Looking ahead support at the April low of $1321 (exactly $600 below the September 2011 peak) now looms large and can be expected to act as a magnet pulling prices lower in the coming session. As with $1,520 this support can be expected to be strong, and could potentially redistribute the balance of power between buyers and sellers, leading to another bounce for the metal. On the other hand a breach of this support would increase the chances of another sharp leg lower.

Given the heavy institutional selling and the fact that this tends to be highly calendar based the danger period for gold would seem likely to be the remainder of the current quarter. Given the ferocity of coin and metal purchases in late April we doubt there is much more retail money left on the sidelines at the present time while ETF holdings remain at almost 71 mm oz, close to their level in July 2011. Therefore although we may see an intial bounce the odds of $1321 support holding between now and June 30th therefore seem to be less than even, with a breach of support potentially opening the way for another sharp leg lower for the metal.

As would be expected the breakout by the SPX to a new all time high has been accompanied by an improvement in consumer sentiment with the University of Michigan survey rising to 83.7, its highest level since July 2007, the month in which it became clear that problems in sub-prime lending were anything but "contained". Nevertheless is is striking how tepid sentiment remains compared to other periods in which the SPX was breaking out to record highs. The late 1990's for instance saw readings above 100 for several years while the 80's generally saw readings between 90 and 100 and January 2007 a peak reading of 96.9. Indeed the current reading is still a little below the post 1980 average of 85.9, underlining the significant divergence between sentiment and equity market performance. As most readers will be aware we view this as positive for the equity market and believe it signals that we are still some distance in time away from the eventual end to this powerful bull market.

We are starting to see some signs of distinct weakness in the "high carry" emerging market currencies with the South African Rand (ZAR, green line) falling to a 4 year low at 9.39 this morning and the Turkish Lira (TRY, red line) an 11 month low at 1.839. In the case of the latter an unanticipated 50 bp cut to 4.50% in the local REPO rate would seem to have caused some turbulence in FX markets. The Brazilian Real (BRL, blue) has been gently depreciating in recent sessions to reach 2.03 close to where it started the year. A break above 2.05 would signal a new wave of weakness. The quietest of the 4 "high carry" currencies we track is the Indian Rupee (INR, black line) which has remained pinned under 55 in recent sessions. However, when one factors in the record pace of equity and fixed income flows seen in 2013 the flat performance of the currency does point to underlying weakness which is not surprising given India's massive trade deficit.

Indeed sharply worsening trade balances is a common theme for these 4 countries and the ability of their currencies to keep close to current values is now very dependent on foreign flows. In recent quarters fixed income flows have been vital with the global scrambling for yield forcing vast sums into emerging market local credit. The effect of this can be seen on the chart of the 10 year sovereign yields for the 4 nations. The greatest collapse has taken place in Turkey (now 5.95% down from over 10% at the end of 2011) and South Africa (6.21%). Indian rates have also started to decline sharply reaching a 3 year low of 7.41% while Brazil remains high at 9.90%. With yields no longer giving a comfortable cushion for weakening currencies the danger of total return losses for USD and EUR investors in EM local credit should FX markets start to become less hospitable.

Since we were out for Wednesday and Thursday we did not comment in real time on this week's housing data but we would like to take the opportunity to make the point that overall the evidence continues to build of a strong cyclical recovery in construction.

May's NAHB Sentiment Index showed a bounce back to 44, a level which still implies a modest shortfall from normal conditions being indicated by the survey. However, as we have pointed out before, the large sample size skews this survey towards smaller privately owned builders who are somewhat disadvantaged by access to capital compared to the larger public builders. Indeed we saw two large offerings this week by public homebuilders that underlined their ability to raise debt capital at very favorable terms in the current market. We also note that the survey indicated a new multi-year high for Future Sales (blue), with the only notable laggard being Traffic (green) which we take to be an indication that going round the local building site is no longer considered to be a recreational activity with Traffic limited to serious buyers.

Thursday's Housing Start and Permit data was a more mixed bag. Although most of the attention goes towards the Housing Start data, which was soft (853K vs 970K consensus) due to a large shortfall in the volatile Multi-family Starts data, we have always preferred to follow Permits since these have a better historical track record of picking up the general trend. Overall Permits were 1017K, above consensus of 941K and the best data since June 2008 (which itself was an abnormally strong month). More importantly this strength was reflected in the Single Family Permit data which rose to 617K, the best reading since May 2008 and a rise of 133K (27.5%) over the past 12 months. In other words Permit data points to an acceleration of an already healthy trend and this is more likely to be correct than the sharp drop in Housing Start data.

It should also be noted that this still keeps the Permit data well below its long term average of 975K, and at around a third of its peak reading of 1796K, meaning that the current pace of recovery looks to be sustainable going forwards. It should also be noted that this strong data is being produced in the key spring construction season, meaning that it is likely to be reflected in a considerable pick up in the actual number of homes being built in the future earnings reported by public homebuilders.

One of our few concerns regarding Europe has come from the persistent shrinkage of the ECB balance sheet in recent months, which ran the risk of creating the sort of brief hiatus in financial asset price recovery that took place in the US during the summer of 2010.

We are therefore relieved that this process appears to have been completed, and that although the overall ECB balance sheet continues to shrink modestly, with non-gold assets falling by -€1.8 bln last week to €2071 bln, this shrinkage is now entirely driven by a voluntary run-down of the ECB's deposit facility. This fell by €28.8 to €95.3 bln last week, its lowest level since August 2011. This means that the ECB's balance sheet ex gold and deposits actually grew by €16.9 bln last week to €2075 bln, in line with its level in the middle of March.

This stabilizing of Eurozone liquidity provision is reflected in a much healthier level for the Bloomberg Eurozone Financial Conditions Index {BFCIEU Index }, which has risen from its March 28th low of -0.022 to 0.411 this morning (see chart). This puts Financial Conditions back in comfortably "normal" conditions even though they still lag the "hyper healthy" readings above +1 that have been seen in the US in recent weeks. We view this as a very constructive turn of events for European equity markets, which themselves have performed well since the Cyprus debacle ended last month.

11 months ago we noted a marked and unusual divergence between Germany's ZEW Sentiment Index, which started to fall sharply in June 2012, and the local DAX index, which put in an obvious low at the start of that month. We suggested at the time that readers would do better to bet on the insight of the equity market than of economic sentiment, which seemed to us to be unduly depressed by the long running fiscal concerns of other European nations.

It is fascinating to observe that this divergence remains in place, and that despite the fact that the DAX index has managed to climb from its June 2012 low of 5,914 by just over 40% to its current level of 8,306 the ZEW poll has actually deteriorated from 33.2% to 8.9% over this period (the index is calculated by taking Negative responses from positive responses). Even more surprising is the modest drop in the ZEW from April's reading of 9.2% given that the DAX actually managed to make a new all time high during the last month's trading. Compare this to prior cycles in which a DAX breaking out to new highs has traditionally been accompanied by a strongly rising ZEW at much higher levels than today.

This suggests that the recovery of the German equity market has really caught many domestic observers by surprise, and we suspect that the low polls (which really reflect a rough balance between positive and negative opinion) reflect an emotional response to the perceived tribulations of the European project rather than an accurate reflection of the "corporate opportunity" available to German listed companies. We are surprised that the divergence has remained in place for so long, but frankly as investors we have come to welcome the stubborn sullenness of local sentiment.

Clip concentrates on the bond market and our advice that allocations to high quality credit be cut at the present time.

http://www.bloomberg.com/video/there-s-simply-no-reason-to-be-in-bonds-shaoul-t2Z5RqODQUmBMMMAfQwvBA.html

We continue to track the impact of the BoJ's sudden conversion to the Bernanke Doctrine and one metric we will be watching quite closely in the coming months is the pace of M2 creation. This is because we have generally found that an acceleration of broader money is a reasonable proxy for the "leakage" of the reservoir of base liquidity created by the central bank into the wider economy, with M2 being sensitive to both monetary easing and actual credit creation.

In Japan's case it comes as no surprise to see that M2 creation has been extremely sluggish since the collapse of the NKY index 23 years ago. Indeed with the exception of a brief period in 1998 M2 has never risen by over 5.0% YoY, and has not exceeded 4.0% YoY since the start of this century. Even the brief experiment with QE in 2002/3 failed to generate a surge in broad monetary aggregates, although its abrupt removal in 2006 did result in a sharp decline in M2 creation with predictably depressive effects. As can be seen on the attached chart there has recently been a notable pick up in M2 creation, with YoY change reaching 3.3% in April (above expectations for 3.2% growth), which is the fastest pace since November 2009. Should this metric continue to make progress and breach the 4.0% level later this summer we would have some tangible evidence that stimulus is starting to reach the actual economy.

The Census Bureau Advanced Retail Sales data is a good example of an official statistic that has significantly more econometric and market influence than it deserves to, given that we get extremely accurate and granular sales data from actual store chains approximately 2 weeks earlier than the Census Bureau releases its survey based estimates.

Nevertheless official data maintains its influence over the market mood and we are therefore happy to report decent data for April, with total Advanced Retail Sales rising 0.1% compared to expectations of a -0.3% drop. This keeps up the recent string of decent economic reports that suggests that April has not experienced the sort of "spring swoon" that affected the last three years data. Even more encouragingly ex-gasoline and automobile sales were estimated to have risen by 0.6%, well above expectations for a 0.3% gain. This is hardly surprising given that we already had decent "real" data from the stores themselves but as we note above the official data can often set the mood for a few key sessions and so we are happy enough to get a positive report on the books for the month.

Despite lower crude oil prices India's trade deficit continues to hover around its recent record low with April's deficit totaling -$17.8 bln. This caused the trailing 12 month ma of the deficit to record a marginal new record of -$16.60 bln and suggests that the sharp improvement seen in March export data was simply a result of fiscal year end window dressing. April Exports were $24.16 bln, down sharply from March's inflated $30.8 bln, but up slightly from April 2012 when they totaled $23.8 bln.

April imports were $41.95 bln compared to $37.8 bln a year ago. Gold and Silver imports continued to be very high at $7.5 bln (compared to $3.1 bln in April 2012), caused in part by an attempt to front-run greater restrictions, and also by a surge of Indian retail demand following the sharp reduction in the price of the metal in the middle of the month (we note that today's festival buying has been reported to be much weaker than expected, suggesting that retail fire-power is now largely exhausted). We would therefore not be surprised to see significantly more stringent restrictions on gold and silver imports as well as the extensive shadow banking system built around the metals, which is a further risk for gold going forwards.

Given the sharp rise in US Treasury yields and the renewed decline of gold in recent sessions, it makes sense for us to issue an update on our BAG index. To remind readers this tracks the performance of a portfolio split between Bonds, Apple and Gold (all three of which became heavily over-owned between 2009-2012) both in nominal terms and relative to the SPX index.

As can be seen on the attached chart, despite the decent bounce in the value of the Apple weighting, the index remains in a clear downtrend and has fallen -1.2% today and the same amount over the course of the week. With the SPX continuing to push its way forwards (if we close at the current level the index will have gained approximately 1% over the last week) this has created a new relative breakdown by the BAG index against the SPX. At a ratio of 1.13 the BAG index is back to where it was against the SPX in mid November 2008 and well below its peak value of 1.62 in September 2011 or its level a year ago at 1.46.

As we have stated before, in the current environment of excess liquidity bear markets are starting to reveal themselves via chronic underperformance rather than price declines, which then leads over time to a wave of liquidation and sharply lower prices. We have seen the latter take place in both Gold and Apple in recent months and there are growing dangers that fixed income will come under liquidation pressure if the SPX and other developed markets continue to make gains this quarter.

The past few days have seen the JPY push through the 100 barrier reaching a 5 year low of 101.60 against the USD, which could be said to have brought an end of the long period in which the Japanese currency was substantially overvalued against the USD. At the same time the CNY has continued to strengthen against the USD, reaching a 19 year high of 6.13 on Thursday before moving back to close the week at 6.14. As can be seen on the attached chart, the CNY is now approximately 5% below its level prior to the massive 1994 overnight 50% devaluation of the currency from 5.82 to 8.72 and at the current pace of appreciation would reach its pre-devaluation level in mid 2015. Given the fact the the USD is valued at a fairly normal level against most international currencies, this means that the CNY is starting to look somewhat overvalued at the current USD conversion rate.

This twin shift in currency values is having a radical effect upon the relative value of the JPY against the CNY, with the cross reaching 16.55 this morning, its highest level since 1998 (when the buildup to the LTCM crisis was distorting currency markets). This means that Japanese exporters are now more competitive than they have been against their Chinese counterparts than at any point during this half generation. We believe that this is going to start having a major effect on the market share of global exports that these two countries capture in the months ahead, with Japan being the clear winner in the tussle. This is potentially the greatest direct source of incremental earnings from the Japanese embrace of the Bernanke Doctrine, although we continue to value the cultural shift that the policy implies as a greater source of long term opportunity for investors.

We would also imagine that should matters play out in the manner we expect then a significant spillover into the political area will take place. Relations are already tense between these two nations with several territorial disputes in recent months. We would expect some vociferous complaints from China if Japanese monetary action starts to harm its export driven sector which is already showing signs of pressure.

Despite some public attempts by Chinese monetary authorities to rein back non-bank credit creation in late March (primarily though new regulations over wealth management products), the April Monetary and Loan data shows no deceleration in the growth of China's credit bubble.

Total Social Funding reached 1750 bln CNY, out of which 792 bln CNY (45.3%) was made up by CNY bank loans. Although this represents a drop from March's record 2,544 bln CNY it should be remembered that March was partly boosted by the lagged effect of the Lunar New Year falling in February. April is still one of the strongest months on record and the data takes the trailing 12 month ma up to a new record of 1567 bln CNY. This means that total Social Financing over the last 12 months reached 18.804 trln CNY, or approximately $3.06 trln at the current exchange rate. Thus far in 2013 Social Financing is running at an annualized pace of 23.7 trln CNY, or $3.86 trln. Outstanding Social Financing has now reached 159 trln CNY ($23.6 trln), an increase of 20.2% over the last 12 months and 4 times the level seen in February 2007. As the attached chart shows non-bank credit creation has been the dominant cause of this parabolic surge in outstanding credit, although the former has still be growing at almost 15% over the past year.

As would be expected this has resulted in a pick up in M2, which tends to correlate with credit creation, and this has grown 16.1% over the prior 12 months. Narrow money on the other hand, which is much more sensitive to central bank liquidity creation, continues to grow at a much slower pace. M1 grew by 11.9% over the last year while M0 grew by 10.80%, while the PBOC's balance sheet (through March) grew by a mere 5.25%. We therefore continue to see a pattern of very rapid credit growth outstripping the provision of new liquidity by the PBOC.

At some point in time either Chinese monetary authorities will start to seriously tackle this out of control credit cycle (which would start the clock ticking on a credit crunch) or the amount of credit issuance will simply overwhelm base money (as happened in the US in 2007/8). The alternative scenario of the PBOC starting to accelerate liquidity creation at this point in the cycle would point to rampant asset price (and possibly consumer price) inflation, with clear risks of social unrest. None of these outcomes strike us as palatable, but at a certain point in a cycle authorities are left to pick their poison, and China would appear to have arrived at this uncomfortable juncture in 2013.

SNB FX reserves were trimmed slightly in April as the CHF/EUR cross remained comfortably above the 1.20 intervention level for the entire month. Total reserves at the end of April were 434 bln CHF, a drop of 4 bln CHF (approximately 1%) from the record 438 registered in March. Obviously this does not constitute a change of significant magnitude and even were reserves to now start to drop gently in the months ahead (certainly a possibility given the improving tone within Europe) there would still be a vast pool of excess liquidity within the Swiss financial system. As we have commented before, there is increasing evidence of this leaking out into the actual economy with housing and commercial property now becoming inflated. We are yet to see any sign that the SNB views this as a major policy concern, but we would expect a shift in policy emphasis later this year should the current trends remain in place.

Germany's Factory Order data for March suggests that the draw-down in activity that took place during the Eurocrisis may have completed its course, paving the way for a further period of industrial expansion. The Bundesbank's index rose to 105.6 (2010 = 100), for the strongest reading since March 2012. Although there is some danger in relying on a single monthly reading of a volatile series recent reports had already indicated that the deterioration of 2011 had stabilized around the 100 level and it is our belief that future reports will (erratically) take the index back above the 110 level by the middle of summer (the index had a post crisis peak of 113.7 in June 2011). This local DAX index would appear to agree with our assessment, since it broke out this morning to a new all time intraday high, surpassing the 2000 and 2007 peaks in the process.

Of all the major indexes the DAX bears the closest long term resemblance to the SPX (see chart) and unsurprisingly we are bullish on both markets at the current time. In recent years the ratio of the two indexes has been between 4.5 and 5.5 for most of the time. Using a multiple of 5 this would suggest that an SPX of 1700 would correspond to a DAX around 8500 while a blowout SPX at 1800 would generate a price target of 9,000 for the DAX.

April's update to the quarterly FRB's Loan Officer Survey shows a distinct easing of lending standards took place since the start of the year with 13 out of 68 responding banks reporting that standards "eased somewhat", up from 5 in the January 2013 report. This is the highest number of easing banks seen since May 2005 which just about marked the peak of the housing boom. The remaining 55 banks reported unchanged conditions with no bank reporting a tightening of standards. As may be expected this shift towards easier standards comes at a time that the resilience of the local economy is finally being granted some credence. We would expect a further shift towards easier standards going forwards and for this to be reflected in C&I lending which looks poised to reach a new record (measured as outstanding loans on bank balance sheets) sometime later in 2013 (See chart).

We note that the Merrill Lynch MOVE © index, which measures the implied volatility of one month Treasury options for notes and bonds between 2 and 30 years maturity, fell to an all time low of 49.04 on Friday. In recent months the index has pushed progressively lower indicating increasing belief within the Treasury market that yields will remain range-bound during the near to mid term.

No doubt much credit for this can be given to the FOMC, who with its constant and forceful guidance has created a firm belief that nothing can go awry for the Treasury market for as long as its will to pursue unorthodox monetary measures remains in place. As we have suggested before, the belief of today's bond market in the Bernanke led FRB is every bit as deep as the trust in the Greenspan FRB at the peak of the great 1990's bull market.

We ourselves take less comfort from the current state of affairs, since it is increasingly hard to reconcile the significant overweight positions in fixed income with the dreadful relative performance versus a diversified basket of high quality equities. The fact that we have managed to breach the 1600 level in the SPX without triggering a mass re-allocation out of fixed income does not mean that it makes sense to continue down this path. This is particularly true given the fact that the FOMC's chosen target for unemployment is now 7.5%, considerably nearer to 6.5% than it was last August when the decision to target it was pre-announced at Jackson Hole. That the MOVE should collapse in the face of April's strong payroll report was a strange reaction, but one that is at least consistent with the stubborn belief that exists in the bond market at the current time.

Total Spanish unemployment fell by -46.1K in April, rather better than the flat report, which had been expected. Although total unemployment has risen by 244K (5.2%) over the last year, this represents a fairly sharp improvement from annual job losses of 524K in the year ending May 2012 and there are signs that the local employment situation may finally be stabilizing albeit at a socially unacceptable level of around 5mm. This compares with a pre-crisis norm of around 2mm to 2.2mm, with gives an accurate sense of the scale of destruction that took place over the last 6 years.

Perhaps surprisingly the most encouraging data in recent months has come out of the construction sector which was (literally) decimated by the crisis. After rising from approximately 250K pre-crisis to a total of 810K in March 2012 the total unemployed in construction has fallen to 742K in April 2013. As a percentage of total unemployed construction rose from around 11% pre-crisis to 20.4% in early 2009, but has subsequently fallen back to 14.9% admittedly due to a deterioration of the general service and industrial sectors as much as an improvement in construction)

Despite over 18 months of fiscal stimulus and interest rate cuts (partially reversed by the recent hike in the SELIC) Brazil's Industrial Production data continues to show a steady slowdown in activity. March's data estimated a drop in Industrial Production of -3.3%, compared to estimates of a -2.4% decline. Although this is not a deep shortfall given the volatility of the data, it does reinforce the rather dismal run that the data has been on since the middle of 2011, with only two positive reports being generated over the last 18 months. Thus far the depth of the decline has been shallow at around -2% per annum but the length of the decline is now reaching historic proportions and has taken place against a backdrop of consistent expectation that things would improve in the near future. Instead there is a significant danger that another leg lower will be experienced later in 2013, leading to a sharp drop in confidence by market participants.

April's Non Farm Payroll report is a solid set of data that should go a long way to correcting the unnecessary angst caused by the March report, not least since that month's data has now been revised up strongly from 88K to 138K in Total Payroll and from 95K to 154K in Private Sector gains, making this in retrospect a normal set of data. This is not the first time this cycle that we have seen initially weak data revised strongly higher within 30 to 60 days, and we have to assume that market participants will now start to develop a much greater resilience to weak payroll data should it be released in future months.

As for April's report itself, the BLS estimated gains of 165K for Total Payroll (beating 140K consensus) and 176K for Private Sector gains (150K consensus), in line with the trailing 12 month ma of 180.5K. It also revised higher the already very strong February data which now shows gains of 332K Total and 319K Private Sector gains, making this something of a "blow out" month in retrospect.

The icing on the cake was supplied by the Unemployment Rate falling to 7.5%. As we had pointed out last month the Household Survey has been unusually poor for several months making it highly likely that April would supply strong data. This duly arrived in the form of of a 293K monthly gain, which had a predictable effect on the Unemployment rate. As the attached chart shows, Unemployment remains in a well defined declining trend, which is on track to take the rate to 6.5% around this time next year, approximately 18 months ahead of the FOMC's tardy schedule. Perhaps a more relevant time period is Q3 2013 when the rate may well be pushing against the 7.0% level, which we suspect would be the point at which the bond market starts to exhibit clear concern that the FOMC has been way behind the curve in its assumptions and actions.

It comes as little surprise that the UBS Swiss Real Estate Bubble Index moved further into "risk" territory (calibrated between a reading of 1 and 2), with the index reaching 1.17 the highest level since Q3 1991. Since back then the market was in the midst of a collapse, a more accurate comparison would be Q4 1987 when the index reached 1.19 on the way to a peak of 2.66 30 months later. It is interesting to note that house prices increased by a little over 30% during the final phase of the housing bubble followed by a 9 year decline that took them back to where they were in late 1987. We would not be surprised to see a repeat performance this time around.

It is also interesting to note that 25 years ago the SNB was also caught keeping interest rates too low for housing due to concerns about the overall industrial economy, with the mortgage rate actually falling from around 5.25% to 5.00% over the last few quarters of the bubble, followed by a long and powerful climb up to almost 8%, where the mortgage rate remained until 1992. The current mortgage rate is approximately 2.7% where it has been for the last two years but this disguises the considerable effect that the SNB's massive liquidity provision program (which is designed to keep the CHF above €1.20) has had on local monetary conditions.

The effect of this on Swiss house prices is easy to see on the chart, and indeed a similar level of appreciation is taking place in the rental market at present. At some point in time this is likely to cause a re-appreciation by the SNB of the balance of risks facing the Swiss economy, with currency manipulation losing its primacy in favor of a more balance approach. However, we do not expect this change to take place anytime soon, meaning that the local housing market is likely to continue to tighten considerably in the months ahead.

An excellent article that points at the central folly behind the ongoing debate over austerity and stimulus.

www.bloomberg.com/news/2013-05-01/reinhart-rogoff-uproar-settles-nothing.html

Regardless of what tomorrow's non-farm lottery generates, the message from the Initial Claims data is that the US employment situation has started to improve markedly in recent months. Although it is possible that US firms are no longer firing (leading to lower Claims data) but still unwilling to hire (leading to anemic Payroll gains), we believe this tendency is exaggerated by the data and most current economic analysis (including that followed by the FOMC) and that this will eventually be revealed by improving Payroll gains and revisions to prior data (although we give no promises regarding April's report).

Looking at this morning's data, weekly Initial Claims fell to 324K, the lowest reading since January 2008 (when Claims were just starting to surge higher) and substantially below the estimate of 345K. Last week's data was revised higher by 3K to 342K and this took the 4 week ma down to 342.3. It is important to realize that this improvement is taking place in what can be a tricky time for Claims since the favorable winter seasonal adjustments are now giving way to the more demanding springtime schedule.

This means that the recent improvement in the headline data represents a more significant drop in nominal Claims in the "real economy" than the headline data would suggest (see chart). This ties in with our expectation that the recent recovery in domestic construction is starting to generate measurable gains in overall economic activity, making a "spring swoon" in economic data rather less likely to take place in 2013 than the prior 3 years.

We always caution that when following central bank policy it is what they do not what they say that really matters. In the case of the BOJ there is little doubt that they have "walked the walk" in recent months with the monetary base surging from a powerful wave of asset purchases. April saw an increase of ¥7,130 bln (5.13%), which excluding the March 2011 response to the tsunami and earthquake is the largest monthly increase on record. This takes the YoY increase up to 22.98% and it seems clear that the annual pace will accelerate for a number of months going forwards.

None of this will come as much of a surprise to markets, which have already priced in a vigorous BOJ liquidity campaign. As can be seen on the attached chart there is a strong long term relationship between a stronger equity market, weaker currency and rising monetary base in Japan. For this to prove true this time around the rapid injection of liquidity will have to generate some actual credit creation and/or investment in business opportunity. It is too early to be sure that this will take place but the speed and scale of the policy change, and the fact that it was generated by an electoral mandate, does suggest that sentiment in Japan may finally be shifting towards a more opportunistic, pro-cyclical stance.

In a widely expected move the ECB elected to lower the Main Refinance Rate from 0.75% to 0.50% this morning and although we doubt that this move will have much practical effect at the economic level, it is a useful reminder that the ECB has become a much more market friendly institution under President Draghi than it was over his overly rigid predecessor.

From our perspective the provision of ample liquidity now overrides the need to lower interest rates and we do remain concerned that the rapid drawdown of the LTRO facility (see chart) may develop into something of a funding "air pocket" should credit markets take a turn for the worse. At the same time we recognize that as well as being an alternative to QE the LTRO performed some of the same function that TARP did for the US banking system, and the early repayment of that facility proved simply to be a sign that the worst was past for the stronger banks US banks. This is likely to be true of the LTRO as well, while the rapid and powerful improvement in peripheral sovereign credit markets proves that acting as a "lender of last resort" is a viable alternative to the "Bernanke Doctrine" (although much less profitable for the central bank itself). Whatever the truth behind the numbers this morning's move can only be seen to be palliative for asset markets.

We generally ignore the myriad of international PMI reports that come out each month since most lack the provenance of having been calculated through multiple cycles, while many are now produced by financial firms rather than manufacturing institutes (we for our own reasons prefer the latter).

Nevertheless we do think Australia's AIG (Australian Industry Group) report for April deserves some attention since it would appear to show a sudden and severe deterioration in that nation's industrial economy. The headline index fell to 36.7 from 44.4, creating the lowest headline reading since April 2009. This is also the 14th consecutive month in which the index has been below 50 and the combination of sustained contraction followed by a sharp collapse suggests a considerable slowdown in activity has taken place in recent months. Most interestingly this seems to be centered around Australia's export activity, with the export sub index falling to an all time low of 24.5 in April, compared to the 2008/9 cycle low of 37.6 recorded in March 2009.

Although China is not Australia's only export market, it does dominate that country's trade, and we would take this data as a useful indication that Chinese economic activity has experienced rather more difficulties than the official data indicates. We would also tie the AIG index fairly closely to the industrial commodity cycle, attached is a chart comparing the AIG index to the LME price of copper and as can be seen there is generally a close relationship between the two. We are therefore unsurprised to see copper struggling to hold key support at the $7,000 level at precisely the time the AIG index has started to indicate a meaningful slowdown in Australian industrial activity.

The ISM Manufacturing Survey for April was essentially in line with expectations with the headline index coming in at 50.7 compared to consensus expectations of 50.5. Although this represents a slight slippage from March's 51.7 reading, the bulk of this decline was caused by a sharp drop in the Prices Paid index (not shown) which fell to 50 from 54.5, the lowest reading since July 2012. We see this as resulting from generally lower commodity prices that have been caused by turbulence in financial markets and slippage of external demand, but if anything for the US industrial sector this represents a tailwind for future expansion and corporate margins.

The key New Order index (red) actually improved slightly to 52.3, suggesting that demand remains in a steady increasing trend and the same is true of Production (blue) which rose from 52.2 to 53.5. In addition Backlog (not shown) rose to 53 from 51 while Inventories (olive) fell sharply to 46.5. This represents a very healthy combination of metrics that suggests that we remain in the middle of a long period of sustained manufacturing growth and this to our eyes more than compensates for the slight slippage in the overall index. Although we expect many to use the headline report as evidence of a spring slowdown a considered view of the data simply does not support this conclusion.