Attached is a comparison of today's FOMC statement with that of June 19th (the date of the last meeting). As would have been expected little of substance was changed in the text, with the change from the description of a "modest pace" to a "moderate pace" of recovery being typical to the alterations made with the FOMC anxious to avoid another sell off in fixed income markets.

Probably the most interesting decision was to add the note that:

"The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance"

This is a useful reminder that the current FOMC interprets the portion of its mandate relating to inflation as a duty to make sure that it occurs. This is very different from the "price stability" mandate of earlier versions of the FOMC.

Regarding inflation we see no obvious push higher in CPI, but equally we see none of the signs of "deflation" that Chairman Bernanke so eloquently described back in November 2002:

www.federalreserve.gov/boarddocs/speeches/2002/20021121/

Although interest rates have hit the "zero bound" described in this speech, this is currently more an outcome of FOMC policy rather than market forces. Certainly few of the difficulties described in servicing debt described in this speech are still relevant today, although admittedly this was not the case 5 years ago and it is far from clear that the economy would suffer a sharp reverse if the FOMC were to cease asset purchases at the current time.

Meanwhile outside of the statistical closet of CPI the signs of an inflationary impulse are building. Higher asset prices are starting to become prevalent in the US economy, with a number of residential and commercial real estate markets back to their prior cycle highs and the SPX breaking out into blue sky territory. We suspect this is a harbinger of a comprehensive victory over the foe of "deflation", and a return of the more common policy concern of inflationary pressures.

At a time that the market seems concerned to weigh up the "dovish credentials" of potential successors to Chairman Bernanke it would appear that the ability to calm a bond market spooked by overly loose monetary policy is the most likely skill required by the time the hand-over takes place.

Japan's June Housing Start data held on to most of the strong gains delivered in May with an annualized rate of 976K (982K consensus) dropping from 1027K. This still represents a 16.6% YoY increase in activity, and takes the 12 month ma up to 920K, the highest level since June 2009. In other words the report is supportive of the notion that Japan's residential construction industry is enjoyed a rebound in activity that we would expect to extend for several months going forwards. It should be noted that pre-crisis activity was stable around the 1.20mm home level, and a return to this sort of activity would involve around a 25% increase in current activity.

The ADP Employment Survey for July got the July data cycle off to a strong start with an estimation of 200K new private sector jobs, above expectations of 180K. June's report was also revised higher from 188K to 198K enhancing the quality of today's report. This takes the trailing 12 month ma of the report up to 166.9K, which trails the equivalent level of the BLS Private Sector report by almost 30K. It should be noted that since its methodological revision (which ironically was designed to bring the report into line with the BLS data) the ADP report has been consistently less bullish than the official ADP report, whereas previously the 12 month ma were virtually indistinguishable (although monthly variances were considerable).

Expectations for Friday's report are 185K for Total and 195K for Private Sector job gains. Today's ADP report is supportive of this outcome but in no way guarantees that it will be delivered. We would assume that any report above 225K for Private Sector gains would constitute an upward surprise, while a number below 170K would bring considerable relief to the bond market.

Ireland's Live Register of Unemployed citizens continues to improve sharply from its elevated level with July witnessing a -3.2K decline to 419.2K while June's report was revised from -2.5K to -2.9K. This represents the sharpest 1 month fall in the Register since December 2011 but what is more important is that a clear trend of improvement has been established with 13 straight months of falling data. Over the past 12 months the Register has fallen by -17K, which is the sharpest decline since May 2001 when the Register had fallen below 140K for the first time in its history.

The decline in the Register led to a small fall in the Unemployment Rate to 13.5% from 13.6% and clearly this degree of unemployment remains a debilitating constraint on the domestic economy. Nevertheless the sharp rate of improvement should not be ignored since it is the re-entry of individuals into employment that drives new economic activity. Ireland looks to be poised for a period of substantial improvement with a large available pool of labor now apparently in some demand from local businesses.

Although the headline Conference Board Consumer Confidence Index ticked slightly lower to 80.3 from last month's level of 82.1 (revised up from 81.4) there is some significant evidence in this month's report that consumers are starting to display an increasing awareness that economic conditions are improving in the US.

This can best be seen in the Present Situation Index, which rose very strongly from 68.7 to 73.6, the best reading since May 2008. Although this was contradicted by a decline in the Expectations index from 91.1 to 84.70 in our experience consumer's are much more reliable when talking about the present than predicting the future, and as can be seen on the attached chart the current reading is the latest in a string of improving reports.

The other area of clear improvement comes in employment sentiment. The Jobs Plentiful index rose to 12.2 in July, the highest reading since September 2008 while the Jobs Hard to Get Index fell to 35.5, which is the second lowest reading since September 2008. This creates the tightest spread between these two indexes since the month in which Lehman collapsed, at which time the Unemployment Rate stood at 6.1%. This suggests that US consumers are seeing rather more improvement in employment opportunity than has thus far been detected by official employment data.

In a widely expected move the RBI chose to hold India's Repurchase Rate at 7.25% and made no change to any other reference rate. What was more interesting than the decision itself was the commentary that attended it. The RBI made clear that its primary concern is now the Rupee. The RBI commented specifically on the need to rein in the unsustainable Current Account deficit and made it clear that its recent tightening of monetary policy will remain in place for a good while longer.

This determination is now shared by the Finance Ministry whose Chief Economic Advisor, in perhaps a deliberate use of Draghi's famous intonation, stated that India "will do whatever it takes" to stabilize the INR. Unfortunately the response of the market to the use of this magical phrase proved to be less than enthusiastic, with the INR falling -1.8% to close back above the key 60 level this morning at 60.48. The all time low of 61.21 is now clearly at risk of being surpassed.

Thus far the large cap SENSEX has remained fairly well behaved, with the index closing right on support at its 200 day ma, and almost exactly where it started the year. Small cap equities have suffered much more damage and we note the BSESMCAP index fell to a new 4 year low this morning (see chart) taking its YTD decline down to -27.4%. We believe the latter is probably the more accurate gauge to the level of distress being felt in the domestic economy underlining the considerable risk that the RBI's "currency first" policy may cause a further sharp downturn in economic activity in the weeks ahead.

US Pending Home Home Sales remained close to the elevated level reached in May, with the seasonally adjusted index falling by from 111.3 to 110.9 (2001 = 100). This caused the trailing 12 month ma to rise to 104.80, the highest level since July 2007. The NSA report shows the importance of strong Pending Sales at this time of year, with the index reaching 128.5, its best June reading since 2007 and well above the average of 110 for June reports between 2007 and 2012. In other words this is another very strong set of data that suggests that the sudden rise in mortgage costs has not significantly affected housing demand.

India's money market rates continue to show a fair degree of distress has been caused by the RBI's sudden tightening of monetary conditions. This morning saw the 3 month interbank rate widen another 55 bp to 10.73% the highest level since November 2008 if one excludes the financial year end squeeze of March 2012 (a somewhat artificial event caused by companies hoarding cash to window dress balance sheets).

The RBI raised the stakes further this morning by stating that "The priority for monetary policy now is to restore stability in the currency market so that macro-financial conditions remain supportive of growth". This statement is starting to become self defeating, if a stable INR comes at the expense of dramatically worse financial conditions.

Unfortunately for the RBI the weakening of the INR has been caused both by a large current account deficit (which has been in place for several quarters) and a sudden reversal of foreign flows into both equity and debt markets. Cumulative 2013 Equity flows have fallen from $15.3 bln on June 10th to $12.3 bln on July 26th, one of the sharpest withdrawals of capital in recent years. The picture for bonds is even worse, with peak flows of $5.58 bln on May 21st turning into a net outflow of -$3.25 bln on July 26th, the largest ever YTD outflow of fixed income investments since the data starts a decade ago.

In other words India would appear to have gone "back to the future", suffering from an old fashioned currency crisis, with the RBI responding in the manner of a EM central bank of 15 or 20 years ago. The clear danger is that monetary tight policy acts to worsen economic conditions which in turn further undermines investor confidence. Under such circumstances the currency could continue to weaken even as the RBI acts to protect its value, making the policy an exercise in futility.

The China Business Cycle Index, which is a joint-creation of the National Bureau of Statistics and Goldman Sachs is one of the few official statistics that actually seems to fluctuate to a credible degree across the months of publication. The index is calibrated with 5 categories of activity:

Very Hot 136.7 and above
Hot 116.7 to 136.7
Stable 83.3 to 116.7
Cold 63.3 to 83.3
Very Cold below 63.3

Over the 20 years of publication readings have fluctuated from a high of 146.7 (July 1993) to a low of 55.30 (June 1999). Over the last decade (a more relevant period) the range has been between 123.30 (January 2010) and 74.70 (January 2009) (see chart).

June 2013's reading of 84 takes the index down to the boundary between "Stable" and "Cool" and also marks the lowest reading since the sharp rebound in activity took place in mid 2009 in response to China's massive monetary stimulus. The brief 2012/13 recovery fueled by massive credit expansion would now seem to have reversed and we would expect this index to move into "Cold" territory perhaps as early as next month.

It should be noted that recent policy announcements from the new administration can be expected to play a part in this process, with a halt to new party headquarters being announced last week and this morning seeing an emergency audit of all government debt (see link) http://www.bloomberg.com/news/2013-07-28/china-to-audit-government-borrowings-as-risks-to-growth-increase.html

One would imagine that the findings of this report will not be pleasant, and the decision to launch it in the first place should be taken as evidence of a re-assertion of centralized control over the economy. Our assumption remains that a sharp slowdown in both actual and reported activity will take place by the end of this year.

It would appear that the Brazilian employment cycle has finally peaked, some two years after the local equity market moved into bear conditions. June's Unemployment Rate reached 6.0%, above expectations of a flat report at 5.8%. This represents the first annual increase in the Unemployment Rate since August 2009 (when the rate was 8.10%). Given the fact that unemployment is typically a late cycle phenomenon with a strong trend we would expect to see a sustained increase in the rate from this point onwards and a move above the 6.5% level would to us signal a genuine change in conditions.

Although worsening employment conditions could be expected to have a generally dampening effect on economic activity we would be particularly concerned about its effect on personal credit default. Even with unemployment at a record low this managed to spike up from 5.7% to 8.2% between 2011 and 2012. Tightening of underwriting standards took the default rate back down to 7.50% this year, but should Brazilians start losing jobs a steady worsening of credit performance should be expected.

The Census Bureau estimation of New Home Sales activity suggests that the recent rise in mortgage rates has had as little impact on demand as we had anticipated.

Total New Home Sales were estimated at 497K, above expectations of 484K, representing the highest level since May 2008 and a 38% increase YoY. Some of this gloss was removed by a downwards revision of prior sales of 38K but we really would focus on the clear upwards trend in sales rather than the volatility of monthly data. Perhaps most importantly even after the recent surge in activity New Home sales remain at 47.4% of 2001 activity, compared to Existing Home Sales at 85.2% and New Car Sales of 90.2%. Given the highly cyclical nature of the New Home market we would expect this gap to be narrowed considerably in the next 18 months, suggesting that a continued acceleration in activity will take place.

As would be expected inventory levels remain very tight with a total of 160K homes or 3.9 months of sales, equivalent to the level seen in October 2004. Perhaps most significantly only 36K of these houses have been completed, or about 3 weeks of supply, while 93K are under construction and 32K have not yet been started. This implies a significant increase in construction activity will be required in the months ahead.

Japan's exports were 6061 bln JPY in June, a rise of 7.4% from June 2012 but still well below the last June cycle peak of 7152 bln JPY recorded in 2008. Consensus was for a rise of 10% but given the volatility of trade data month to month this is still within the error tolerance.

What is perhaps more interesting is the differing performance of Japanese Exports to the three main economic regions of the US, China and the EU. The US has once more become Japan's largest export market, with June seeing 1133 bln JPY of goods supplied, a 14.6% rise on the activity of June 2012. Exports to China on the other hand grew by a sluggish 4.8% to reach 1080 bln JPY, suggesting that Chinese domestic demand has significantly down shifted in recent months. Meanwhile Exports to the EU were 563 bln JPY, an increase of 8.6% YoY. This is the first time since September 2011 that EU export activity has risen YoY, a function both of the weaker JPY making Japanese exports more competitive but also a stabilizing of EU demand after the long post-Eurocrisis drawdown in activity.

In recent weeks the RBI has announced a number of surprising and aggressive measures to support the rupee, with both interest rates and reserve requirements being tightened. Although these measures may have contributed to a stabilizing of the INR close to the 60 level, the currency remains prone to weakness and is being undermined by a wide current account deficit and persistent equity and fixed income outflows (a new phenomenon).

Meanwhile the tightening of monetary policy is starting to considerably affect short and longer term interest rates, particularly in the interbank and money markets. This morning saw the overnight call rate spike 264 bp to 9.94%, quite a move even for the volatile overnight market and a 24 bp pop in the 10 year sovereign yield to 8.40%, the highest yield in 13 months (see chart).

Perhaps the greatest disturbance has taken place in the Non Deliverable OIS Spread, where the 1 and 2 month yields now approach 11% up almost 250 bp from their level of a month ago. Although the spike in yields is less oppressive further out, a very significant repricing of liquidity has taken place over the last 30 days with the bulk of the change taking place over the last week (see chart).

As we saw with China a few weeks ago money market spikes can dissipate as quickly as they emerge, but generally it takes some central bank intervention to help things settle down. In the case of the RBI this help has not been forthcoming, indeed additional tightening measures have been implemented as recently as yesterday. Unless the INR were to suddenly appreciate it is hard to see the RBI changing its stance in the short term, and it may take some clear distress to get them to reverse course. As would be expected this has started to unnerve the financial sector, which basically sat out the recent rally in the overall equity market before starting to correct substantially in recent sessions.

The spike in treasury yields, coming at a time that most other emerging market credit markets have settled down (but not recovered their June losses) is equally problematic, since it should ensure that the local corporate credit market for new issues remains shut down. This will considerably compound the effect of tight banking conditions and the risks of an accident are growing in India at the current time.

Brazil's Current Account and FDI data for June showed some improvement from the poor data of recent months. The Current Account deficit narrowed to -$3.953 bln, compared to a level of -$4.393 bln in June 2012. The 12 month cumulative deficit was -$72.4 bln, or 3.17% of GDP. FDI had a surprisingly strong showing at $7.17 bln, the best reading since October 2012 and the strongest June since 2007. In comments made after the release the government estimates July FDI to be a little more than $5 bln. Overall flows (FDI - CA deficit) were -$6.9 bln over the last year, compared to a reading of $12.2 bln in June 2012, which shows that June's better report was sorely needed.

Ireland's battered property market has finally turned the corner by registering not only the strongest monthly price rise (1.2%) since September 2006 but also a small YoY increase in prices (also 1.2%) for the first time since January 2008. Of course during this 5 year draw-down prices have collapsed, with the official index approximately 50% lower than it was at the peak. As would be expected the Dublin market continues to lead the way, with June increases of 1.7% and an annual increase of 4.2%, although the Dublin index remains at 60.2, down from a peak of 134 in 2007. Nevertheless the point at which prices stop going down and start to appreciate is an important milestone on the way to recovery, since it suggests that functioning markets are starting to emerge in which sellers at least have the ability to stand their ground. We are hopeful that the recovery in prices will gather pace, and further encourage some migration of buyers into the marketplace.

Although the modest miss against expectations will have the headline writers focusing on mortgage rates the June Existing Home report actually shows that the robust recovery in activity has absorbed the recent rise in rates with very little disturbance.

Total Sales were 5.08mm units annualized, down from last months 5.14mm rate (revised down from 5.18mm) and missing expectations of 5.26mm units. Even so this is still a very solid pace of sales, with the "miss" well within statistical tolerance and it puts sales roughly where they were in mid-2007, up a healthy 15% YoY. There was no great difference between Single Family and Condo sales, with Single Family sales totaling 4.50mm, down about 1% from last month.

Single Family inventory remains very tight at 1.96mm homes, the lowest June level since 2001. The average number of days on the market fell to 37, compared to 41 in May and 74 back in February (the latter partly caused by seasonal factors) suggesting that demand is still quite robust. There is plenty of evidence that tight inventory is starting to crimp sales, particularly with regards to distressed sales where the pipline of deals is starting to run empty.

Distressed sales fell to 15% of Total Sales, compared to 25% back in February, while Foreclosed sales now account for just 8% of Total sales, compared to 15% back in February. Thus whatever the numbers may have lacked in quantity they more than made up for in "quality", with more voluntary transactions taking place away from the messy legacy of the last housing boom.

In any economic recovery the data needs to go through a process of becoming "less bad" before it can be considered "good", and it would appear that Italy has started to make the transition into the former category in recent months.

May's Industrial Orders are a good example of this, with the NSA index falling -1.1% YoY to 101.9 (2005 activity = 100). This is the second best (or least worst) YoY performance since November 2011 and caused the trailing 12 month ma to move up to -5.5%, which compares with the December 2012 level of -7.2%. We would hope to see Industrial Orders to start to grow again later in 2013. At their current level they are approximately -10% below their 2011 recovery high, and -20% below their 2008 cycle high. On the other hand they are 10% above their 2009 low, underlining that for the industrial sector this period of economic weakness has been much less destructive than the collapse of late 2008.

Spain's distressed domestic economy continues to be aided by a very powerful export surge which reached €20.9 bln in May, the second highest month on record and the highest for any May. This represents a 7.3% increase on May 2012 activity, which was itself a seasonal record, and the trailing 12 month ma has now reached a new high of €19.12, which compares to a prior cycle peak of just under €16 bln (see chart).

As well as generating corporate earnings and aiding employment this strong export performance has dramatically reduced Spain's long standing trade deficit. May saw a Trade Balance of a mere -€27.5 mln, the second best reading since the data starts in 1991. This took the 12 month ma up to -€1.71 bln, the smallest deficit since October 1998, and this compares with the pre-crisis levels of almost -€8.7 bln. Given Spain's difficulty in retaining bank deposits this massive reduction in the capital negative flows connected to trade has been of significant help in recent months, and if Spain is able to actually move into trade surplus in the months ahead (as Italy has already managed to do) then the positive flows from trade would start to aid the build up of domestic liquidity levels.

As we outlined in the summary of the current Weekly Speculator central banking has recently become dominated by a fetish of communication, in which the distinction between "walking the walk" and "talking the talk" has been become redundant.

We note two very differing views on this new style of central banking (which are central to what we like to term the "Bernanke Doctrine") were published this morning. Arguments in favor of communication were made by RBI Governor Subbarao in a speech to the European Economics and Financial Centre entitled "Central Banking in Emerging Economies Emerging Challenges" (see link):
http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/07EEFCSP072013.pdf

Readers should focus on Section V. in which Governor Subbarao outlines the case behind the use of "Communication as a Central Bank Tool". We are not convinced by the arguments made in this speech, which primarily rest on the few times that a central bank's comment coincided with a sharp (and beneficial) move in financial markets. We could list a myriad of times that helpful comments were made but ignored by cascading markets. Timing (and moderation) is everything with regards to creating credibility.

The opposite viewpoint is offered by Caroline Baum in the attached Bloomberg editorial "Masters of the Universe Don't Need Fed Hand Holding", which broadly echoes the arguments we made in our own research (see link): http://www.bloomberg.com/news/2013-07-17/masters-of-universe-don-t-need-fed-hand-holding.html

There is little doubt that we are currently in the minority at the present time, with many investors (particularly those concentrated in fixed income) exhorting central banks to be ever clearer in their message. Central bankers (who are increasingly drawn from the same narrow pool of academically trained individuals, rather as the French Civil Service came to rely almost exclusively on the closed world of the Enarques) seem only too happy to oblige, with the fetish of communication feeding into their own concept of heightened importance in the aftermath of the Lehman and Euro crises.

As we have already seen with QE3 this presupposes a level of control over markets that is clearly absent, even in those cases that the message is backed up by actual asset purchases. At some point in time the failure of this policy is likely to cause something of a crisis of credibility resulting in a backlash in central banking policy. Although we are unlikely to go back to the dark-ages of pre-1994 secrecy we would imagine that the world of central banking in 2020 will look as different to us as the limited policies used by central banks in 2006 does today.

This week's Initial Claims data erased the July 4th surge in Claims, with the headline index falling to 334K, below expectations of 345K and last week's level of 358K (revised down from 360K). The NSA report showed a large increase in Claims to 408.7K, which is typical for this time of year and once more represented the lowest level for the current week since 2007 (see chart).

The 4 weeks ma of Claims fell back to 346K from 351.3K, taking the data back below the key 350K level. Although we do not expect much more progress to be made in the remaining weeks of summer we are hopeful that the easier post Labor Day seasonal adjustments will allow the average to fall back to around 325K towards the end of 2013, signalling an increasingly healthy labor market.

June's China house price data shows the property market to be in full swing, which perhaps underlines the increasing determination of the administration and PBOC to restrain credit growth in this portion of the economy.

The NBS report (see link):
http://www.stats.gov.cn/english/statisticaldata/monthlydata/t20130718_402912245.htm

UK Unemployment Claimant data for June showed considerable progress being made with Claims falling -21.2K versus -8K expected, and May's data revised from -8.6K to -16.2K. This is the largest monthly drop in Claims since June 2010 and ties in with other data which suggests that the UK economy is now rebounding from its brush with recession in 2011/2 at a faster pace than most considered possible a few months ago.

Total Claims remain elevated at 1478K but we would be hopeful that they can now fall below the plateau around 1450K reached in late 2010. Readers should note that although this is almost twice the level of Claims seen pre-crisis it is far below the levels of the early 1980's and 1990's recessions, although changes in benefit entitlements over the last 30 year have played a large part in reducing Claimants. We remain hopeful that having experienced a deep and long lasting decline in activity the UK economy can now rebound appreciably in the months ahead.

The weekly MBA Mortgage Application data continues to show shrinking refinance activity while purchase mortgage applications remain resilient in the face of higher mortgage rates, although the data is still likely to be effected by the after effects of the July 4th holiday which makes this seasonally a very quiet part of the year for applications.

In terms of the report itself the Refinance Index fell again to 2351, the lowest reading since July 2011 and would seem likely to fall below 2000 in the weeks ahead. The Purchase Mortgage Index rose slightly to 202.70, causing its 10 week ma to dip to 209, compared to a reading of 213 in late May. This took the percentage of Refinancing Applications down to 62.9% of the total, the lowest since April 2011, although this metric is still well above what was seen in the housing boom of a decade ago.

In terms of the types of mortgages used ARMs bounced back to 7.2% this week in volume and 15.4% in terms of value, indicating that borrowers continue to migrate slowly towards this type of financing. With the 30 year mortgage at 4.48% and the 5/1 ARM at 3.53% there is a considerable incentive to take the risk of a variable rate mortgage and we would expect to see more use of ARMs in the weeks ahead.

The June Housing Start and Permit report at first sight shows a sudden drop in construction activity but on closer inspection the draw-down is entirely due to a freakish reduction in the multi-family housing portion of the report that we assume has more to do with the arcane methodology of the Census Bureau than any change in on the ground activity.

Total Housing Starts were estimated at 836K, the lowest since August 2012 and well below consensus of 960K while May's report was revised higher to 928K from 914K. However, Single Family Starts were almost unchanged at 591K (from 596K in May and the strongest June report since 2008) while Multi-Family starts were shown to have dropped -26.71% to 236K from 322K. The latter is simply not a credible piece of data given that a collapse in multi-family housing activity of this magnitude would not have gone unnoticed outside of the walls of the Census Bureau, while the Single Family data is shows the recent recovery in activity to be intact.

Permit data was similarly affected, with Total Permits estimated at 911K, well below consensus (1000K) and May's 985K (revised up from 974). Single Family Permits (the most important metric in the report) actually rose to 624K from 620K, reaching the highest level since June 2008. Multi-Family Permits collapsed -21.4% to 287K from 365K for their lowest reading since June 2012. Again we take comfort from the steady rise in the Single Family data.

Interestingly a separate set of data on Housing Under Construction shows no collapse in Multi Family activity (see chart). Total Housing Under Construction is estimated at 624K units (up from 621K in May), split evenly between Single Family (309K) and Multi Family (315K). As can be seen on the attached chart we have not seen overall construction dominated by Multi Family since the late 1960s and early 1970s when a massive surge in public housing projects heavily weighted the data to the Multi Family sector. Clearly the greatest opportunity for future growth now lies in the Single Family portion of the data, and there was nothing in this portion of the report to suggest that June was anything other than a continuation of the steady process of recovery.

It has been a difficult few weeks for holders of homebuilder equities as investors have fretted that the surge in US long dated yields (and consequently the 30 year fixed mortgage rate) would have substantially impacted the recovery in home sales. We have argued several times that these fears are likely to be misplaced given that even at 4.45% the 30 year mortgage rate is historically cheap, while the alternative of using ARM financing would still keep a mortgage rate well below 4%. Nevertheless the volatility in homebuilding equities has remained considerable and it is clear that a body of opinion has started to fear for the state of the housing market.

It is therefore just as well that today's NAHB Homebuilder sentiment survey came down decisively on our side of the argument, with the index jumping to 57 from 51, well above expectations and the best report since January 2006. Strong gains were seen in all sub-indexes with Present Sales (red) reaching 60 (the best since February 2006), Future Sales (blue) 67 (the strongest since October 2005) and Traffic 45 (the highest since November 2005).

In other words this is a very strong collection of data although readers should bear in mind that since the NAHB is a diffusion index, meaning that you cannot directly compare the data of today to that of 7 years ago. On the other hand what the report does show is that homebuilders feel substantially better about their prospects than they did 3 months ago when the 30 year mortgage rate was close to its record low. We continue to expect this to translate into strong home sales data and corporate reports in the upcoming quarterly earnings reports.

A very detailed article that can serve as a useful source of reference regarding China's shadow banking industry. Since we expect this to become a major preoccupation of market participants later in 2013 it is worth spending the time to understand the basics of what is taking place in China's shadow banking system.

www.bloomberg.com/news/2013-07-15/wealth-products-threaten-china-banks-on-ponzi-scheme-risk.html

The ZEW Investor Sentiment Poll continues to show only tepid enthusiasm for the current state of the German economy with July showing a +10.6% reading indicating a slight majority of those polled had a favorable viewpoint. From our perspective this keeps sentiment very much in the sweet spot as far as the local equity market is concerned, and the ZEW poll remains well below the sort of overwhelming positive consensus that would typically match a market top.

Tokyo Condominium Sales continued to improve in June, reaching 4888, a 22% gain on prior year activity and the strongest June report since 2010. This takes the trailing 12 month ma of sales up to 4096, the highest level since August 2008. Readers should note that pre-crisis activity was around 7000 units a month, meaning that there is plenty of room for further acceleration going forwards. We would hope to see the 12 month ma rise above the 4500 level in the coming months which we would view as a signal that a genuine rebound in sales activity is taking hold.

Interview centered on China with differing views on the meaning of China's GDP report.

www.bloomberg.com/video/china-slower-growth-new-normal-AsC0rWtSSBGn0srAJEUOWQ.html

Tracking China's large and disparate real estate market is made difficult by a lack of quality data with long track records (the latter is hardly a fault of the statisticians, more a reminder of the short history of market based economic exchange in that country) but it does seem clear that activity has re-accelerated substantially from the slowdown that took place in 2011 and 2012.

Attached is a chart of monthly activity estimated by the National Bureau of Statistics (NBS). Although we would not place much reliance on the accuracy of any particular number we would assume that it is at least indicative of trend, and we like the fact that it does fluctuate significantly over time, unlike the stage-managed Industrial Production, Retail and Fixed Asset data.

June data showed an increase in home sales (measured by floor-space) of 30.4% YoY. Although this is the weakest pace for 2013 (which has averaged 41% growth) it is still a very powerful rate of increase, and easily outstrips completed projects which grew 2.7% YoY. We do not find this resilience surprising since it reflects that surge in credit issuance that took place over the last 18 months and only starting moderating in the last few weeks. Given the deterioration in other economic metrics the buoyant real estate data underlines the extent that this has become the sole hot spot in the domestic economy.

Going forwards it will be interesting to track sales and completions and see if they start to react to a slowdown in credit issuance (assuming that one actually takes place). We would expect it to take several months for the full effect of a credit crunch to take hold, but note that in both the crisis of 2008 and the brief "macro-prudential" squeeze of 2011/12 sales activity did turn negative for several months.

The Advanced Retail Sales report is something of a misnomer, since these official estimates actually trail the release of actual (and hence more accurate) sales store data which is generally made available by the second or third day of the month. Nevertheless the data helps fill commentary and media pages despite the fact that its monthly fluctuations generally fall well within statistical error tolerance.

June's report is no exception, with its 0.4% MoM rise falling below expectations of a 0.8% gain, while Retail Sales Less Auto and Gas actually fell -0.1% when it was expected to rise 0.4%. This will undoubtedly generate the conclusion that higher interest rates have somehow impacted general consumption, despite the fact that we saw no evidence of weakness in actual store sales, which were good enough to allow the S&P Retail Index to break out above 800 for the first time in its history and rise 7% in the first two weeks of July.

A more considered view of the data shows that Retail Sales have been in an obvious and steady uptrend for a number of years and June's report does nothing to suggest a top or reversal is anywhere close. In fact the YoY change of the official data actually rose in June to 5.7%, which is the strongest pace seen since April 2012 and well above the estimated change in GDP over the same period of time.

Evidence continues to build regarding the strength of the rebound in the UK domestic economy, which has always been closely linked to the strength of its housing market. July's Rightmove House Price index rose 4.8% YoY, the largest increase since June 2010. At an average £254K the average price of a home in the survey is now at its highest level while the trailing 12 month ma of £240K is slightly higher than the summer 2008 peak of £238K. With interest rates likely to remain low for a substantial period of time we would expect to see an acceleration of activity to match the rise in prices in the months ahead, together with a geographical broadening of the recovery outside of the Greater London area.

China's GDP report is the sort of "big data" that attracts far more scrutiny and commentary than is actually warranted by either its accuracy or illumination. If anything the published data has become representative of a new resolve to break with the policies of the prior administration, partly by being willing to both countenance and admit to a lower pace of growth. Thus the news that Q2 GDP slipped to 7.50% can best be taken as further evidence that a wind of change in blowing through the corridors of Beijing, if only because it as not deemed necessary to publish a higher number.

As we commented at the time the June trade data was published the export portion of the economy appears to be growing substantially less than published GDP, while housing construction and sales appear to be still somewhere in the double digits. Unfortunately it is upon the latter portion of the economy that the hammer blow of PBOC credit restriction is likely to fall, while it is far from clear that a stimulatory counterweight can be found for the industrial and export sectors.

The clear risk is that tighter credit markets will further restrict economic activity in the second half of the year, taking economic growth down to levels unseen since the short collapse of activity in late 2008 to early 2009. 5 years ago the credit spigot was opened to regenerate growth but this came at the cost of a massive mis-allocation of capital. This time around it seems more likely that other measures will be attempted with both fiscal stimulus and a change to the currency regime potential areas of activity.

Regarding the latter we did note that in the immediate aftermath of the release NBS Spokesman Sheng Laiyun did comment that the appreciation in the Yuan has started to hurt export competitiveness. It will not have gone unnoticed in Beijing that allowing their currency to appreciate against the USD has very different effects when the latter is itself appreciating against the vast majoity of global currencies. Should China's growth, and particularly its export sector, continue to falter we would not be surprised if currency management moves to the center of policy consideration.

The increasingly obvious weakness in India's industrial and consumer sectors calls for looser local monetary policy but the twin concerns of a large trade deficit and persistently high inflation (both of which feed into currency weakness) are substantial constraints on further RBI loosening moves.

June's trade data did at least show a sharp reduction in gold imports, with new tariffs slashing imports to $2.45 bln in June from $8.39 bln in May. Although it is possible that some of this activity has simply been replaced by smuggling, with a greater incentive for malfeasance having been created by the tighter policy, we believe that there has been a substantial drop gold imports, which no doubt helped feed into the metal's weakness in late June.

Other than that the sharp drop in gold overall import activity remained quite high at $36 bln, a 0.4% increase YoY. Exports on the other hand weakened by -4.6% YoY to $23.8 bln, taking the trade balance down to -$12 bln. Although this is a sharp improvement from May's massive -$20.1 bln deficit June is generally a stronger month for the trade balance, and YoY the deficit has widened from $11.2 in June 2012 although it is narrower than June 2011's record -$14.7 bln deficit.

However, the sharp depreciation in the INR during June means that in local terms the trade balance is in sharper deficit, reaching - 715 bln INR in June, a new record for this time of year and a widening of 85 bln INR (13.4%) from the June 2012 deficit. This suggests that the trade balance will remain a substantial policy constraint going forwards.

CPI also looks to be at a worrying level, rising from 9.3% to 9.9% in June when expectations were for a flat report. Although good progress has been made in wholesale inflation in recent months CPI (a relatively new measure in India) remains stubbornly high, again worsening the outlook for further monetary easing.

Last night's economic data from India continues to indicate a sluggish industrial sector and a deteriorating trend for local car sales. The latter fell to 139K in June, a drop of 9% from June 2012 and the lowest June activity since 2009. The 12 month trailing ma of car sales has now fallen to 153K, down from 172K in July 2012 suggesting that a steady declining trend has been established. Since car sales surged by 70% from 2008 to 2012 (note there was no deep drawdown in 2008 car sales in India) the scope for a further sharp reduction in activity should not be underestimated.

Industrial Production data was no more encouraging with May seeing a -1.6% drop in activity YoY, the sharpest decline since June 2012. The trailing 12 month ma remains in low positive territory at 1.1%, indicating little or no growth taking place over the last year. We would expect that the recent rise in longer term rates and subsequent shutting of the corporate credit IPO market will serve to further depress industrial activity later this year.

China's Credit and Monetary Statistics for June were always likely to make for fascinating viewing and the data did not disappoint in this regard. At the level of Total Social Financing, 1040 bln CNY ($170 bln) of new credit was issued in June, making this the smallest aggregate increase since April 2012. However, the really interesting distinction was that between the regulated banking sector, which added a fairly generous 860.5 bln CNY ($140 bln) of new CNY loans to the system (this compares to a trailing 12 month ma of 702 bln CNY), and the "Shadow Banking" industry which added a mere 179 bln CNY ($29 bln). This is the smallest contribution from "Shadow Banking" since September 2011, when the industry actually contracted moderately, and has caused the trailing 12 month ma to drop to 809.65 bln CNY ($132 bln).

Within the bucket of shadow banking there are a number of different categories, which show very different levels of activity in June. As we had expected corporate bond issuance collapsed to 40 bln CNY, compared to the average issuance of 268 bln CNY over the prior 3 months. The little issuance that took place is likely to have been restricted to higher quality companies with the high yield market totally shut down over the last 60 days. Should bond issuance remain depressed over the summer we would expect this to translate into lower corporate activity and a higher risk of delinquency.

By comparison Trust loans issuance (which we would loosely term "wealth management" products) continued to be fairly active at 112.2 bln CNY, a faster pace than May's 99.2 bln pace but significantly slower than the February-April 3 month average of 269 bln CNY. This suggests that the PBOC has yet to really get this area of financing under control, which is not surprising given that the violent squeeze on money markets only really took effect towards the end of June.

Where this squeeze is apparent in the data is in Bankers' Acceptance Bills, which withdrew -263.6 bln CNY as banks sought to access liquidity from any available source. We would expect this to rebound back into positive territory in July given the recent normalizing of money market rates.

At the level of Money Supply this month's data showed M1 growth to have slowed to 9.1% YoY, the weakest growth since December 2012 and M2 to slip to 14.0% YoY. This keeps the spread between M1 and M2 at -4.9%, once more indicating that credit growth outpacing more narrow liquidity in China's economy.

Overall this report is in line with our expectations, and keeps the risk of a credit crunch later in 2013 at a fairly high level. We remain concerned that market participants are paying much too little attention to this risk at the current time.

Indonesia's central bank surprised market participants by raising the base rate to 6.50% from 6.00%, versus the 25 bp hike that had generally been expected. This continues the steady tightening of domestic monetary policy that has been the general response of emerging market central banks to the sharp deterioration of foreign investor flows. We note that although Indonesia's currency (IDR) has been relatively stable in recent weeks compared to its emerging market peers it has been in a steady downtrend for several months moving from 8500 in August 2011 to almost 10000 today, a decline of -17.6%. Given that the country's FX reserves fell sharply by -7.05 bln (-6.71%) in June it seems clear that the central bank has been aggressively intervening to manage the pace of decline in recent weeks. The larger than expected move in rates can therefore be seen as an additional attempt to stabilize the currency without relying too greatly on reserves.

Although Indonesia's economy seems to be in much better shape that of Brazil (see earlier note) the substantial rise in local bond yields and now the short end of the curve represents an unwelcome tightening of domestic economic conditions. Should foreign investors continue to withdraw capital from this sphere the danger is that an unwelcome spiral of lower currency rates requires a stiff monetary policy response even as asset prices and economic activity come under pressure.

Estimating Initial Claims over a holiday period is always a tricky process for the BLS and so this week's surge to 360K (compared to consensus expectations of 340K) is well within the error tolerance of the data. We would expect to see this metric move back down to its recent range below 350K once the holiday distortion is completed and in any case the trailing 4 week ma was not greatly affected rising to 351.8K.

What was perhaps a little more interesting was the fact that the NSA report came in at 384.8K, which is the lowest reading for this calendar period since 2006 (see NSA chart). This is perhaps the best way to track the current improvement in Claims data. Until recently the NSA report was running ahead of all data since 2008 (note that Claims only started to surge in the second half of that year) but by now moving beyond the 2007 data, when the economy was stalling at peak activity and employment Claims data is starting to suggest that we are entering a much more positive employment environment.

The fact that last night's decision to raise the SELIC to 8.50% was widely anticipated by the market does not make it any wiser. We warned in May that the move towards higher rates underestimated the underlying weakness of the economy and capital markets and since the May 28th decision to raise the SELIC from 7.50% to 8.00% the IBOV index has fallen from 56,036 to 45,483 (-18.8%) while the BRL has gone from 2.075 to 2.265 against the USD, a decline of almost exactly -10%.

Although we would not expect a significant immediate response to the latest hike it will only serve to make a bad situation worse for the local economy. We also see the decision of the central bank to avoid any change of language since the May 28th statement as a sign that they are more concerned about inflationary pressures than a domestic recession, issuing the terse sentence that

"The Committee evaluates that this decision will contribute to set inflation into decline and ensure that this trend persists in the upcoming year."

as the only guidance for its shift towards higher rates. It is particularly interesting that the Committee refrained from linking rising interest rates to the need to defend the weakening currency, despite the fact that it has been aggressively intervening since the start of June.

Looking ahead we would still expect to see the worsening conditions in the domestic economy cause the central bank to change policy later this year. Unfortunately this suggests that we have yet to see the low in either the local equity, bond or currency markets for the current bear market.

The fact that the July 4th holiday fell in the middle of last week makes this morning's MBA report rather less reliable than normal. Unsurprisingly the Refinance Applications Index fell sharply to 2454, a drop of -4.43% from last week and taking the index back to its July 2011 level. The Purchase Mortgage Application Index also fell -3.12% to 201.70 taking its 10 week trailing ma down to 210.75. However, when one considers that the holiday caused the NSA data to fall -23.16% we would not conclude that a meaningful drop in activity took place last week unless it were confirmed by future reports.

Similarly there was a substantial drop in ARM usage last week, falling from 7.5% to 6.5%. Given the wide spread that still exists between the 30 year fixed and 5/1 ARM it seems likely that this drop is a statistical blip rather than a reversal of trend and we still expect to see substantially more ARM usage take place over the coming months.

China's Trade Data for June suggests that the export driven portion of the economy continues to experience sluggish activity while imports are running substantially below the official estimate of GDP growth.

Total Exports were reported at $174.32 bln, a drop of -3.1% YoY. For the second month running exports to Hong Kong were sharply lower, dropping by 7% YoY to $25.7 bln. This shows that the recent crackdown on false invoicing has had some effect, but it should be noted that this level of activity is still 9% higher than that reported in 2011 and we suspect that there is still considerable statistical fluff in the Hong Kong report. Since Hong Kong represents $24.7 bln (91%) of the entire Trade Balance of $27.12 bln there is reason to conclude that China's true trade position is substantially less buoyant than reported.

Imports on the other hand have been sluggish for several months and June's total of $147.19 bln represented a drop of -0.7% YoY. It should be noted that the 12 month ma of the YoY change is now 4.8%, and this is a reasonable estimate of the underlying pace of activity in the portion of the Chinese economy that has not been driven by the explosion of domestic credit.

Overall this report underlines the significant policy dilemma facing the Chinese administration and central bank. The great motor of the last 15 years has been export activity, but there is little likelihood of this returning to form anytime soon. In recent quarters this growth has been partially substituted by credit fueled land and real estate speculation, together with the attendant financial services (both official and "shadow"). In belatedly seeking to reign in the excesses present in this portion of the economy the risk is that the underlying weakness in other areas becomes more obvious.

We will confess to largely ignoring Venezuela's economic data but this country is an important destination for emerging market bond investors making up over 4.8% of the EMBI benchmark index for the 7th largest holding by country. Given our general concerns about emerging market credit in general we were interested to note that Venezuela's CPI rose by 4.3% for the month of June, taking the YoY increase up to 37.3%, its highest level since February 2003. This compares to a CPI rate of 21.20% in June 2012 and looking at the history of this measure (see attached chart) a rise above 40% would bring into play the danger of a hyper-inflationary episode.

Such an eventuality would create a substantially elevated risk of default for USD credits, since the value of the local currency earnings used to service or repay the debt would be likely to depreciate rapidly. With the benchmark 12¾% 2022 still trading just above par (down from a peak of $122.5 in February but above its level of a year ago) it does not appear that the bond market has started to price in the dangers of an inflationary spiral taking hold.

The early evidence suggests that the massive increase of Japan's Monetary Base via BoJ asset purchases is having a measurable effect on broader monetary aggregates. Last night saw the publication of June data for M1, M2 and M3, each of which moved significantly higher.

M1 grew by 0.32% to ¥532 trln in what is typically a down month for this aggregate, causing the YoY growth to move up to 5.1% from 4.4%, the highest level since December 2011 when the BoJ's response to the tsunami was about to tail off. Although that short increase in liquidity was helpful, it had little effect on broader monetary aggregates, suggesting that the new liquidity provided caused little capital formation further down the food chain from deposit accounts.

The current episode feels somewhat different, since this time there has been a marked pick up in the pace of M2. This grew by 0.62% in June making this the 7th positive month out of the last 8. This has taken the YoY growth rate up to 3.8%, which is the fastest pace of growth since June 1999. Consensus was for a more modest 3.4% growth rate, suggesting that there has been rather more "leakage" of liquidity into the real economy than most observers had expected.

It also means that the current period of QE has now exceeded that of 2002-3 when a similar surge in monetary base only generated a maximum M2 growth rate of 3.7% in March 2002. M1 by comparison soared by 32.6% in the 12 months ending April 2002 before collapsing as the BoJ removed liquidity before it had time to take hold. It is important to note that this time the BoJ has a popular mandate for its current policy and the full support of the current administration, making a sudden about turn in policy far less likely to take place.

As the attached chart shows, during Japan's boom years M2 grew between 8% and 12% before collapsing precipitously between 1990 and 1992. We would not expect to see a return to this sort of pace (partly because CPI is much lower at the current time), but a move above the post 1992 high of 5.0% (recorded in February 1998) would seem to be an achievable target. If this were to occur it would be meaningful evidence that credit formation and the economic activity that is associated with it has finally begun to take root in Japan.

Over the weekend the PBOC released its May update to its balance sheet data. As we had expected this showed a modest increase of 0.45% for the month, taking the balance sheet up to a new record of 30.214 trln CNY (approximately $4.9 trln), up 6.48% YoY. This is the fastest pace of increase since January 2012, but still far slower than the gains seen during the great export boom of 2002-8 or the initial post crisis period of 2009-11.

At the current rate the PBOC's balance sheet is growing a little slower than GDP, but significantly slower than overall credit. Bank credit alone has been growing by around 15% over the last year, and this has taken the ratio of the PBOC's balance sheet to bank credit down to 0.4495, the lowest ratio since April 2005 (see chart). This underlines the effective tightening of underlying liquidity conditions that has taken place over the last few quarters even as credit has continued to flow freely.

Of course bank lending is only part of the story, as we have highlighted before "shadow banking" has become a much more powerful force in China since the post-crisis loosening of monetary conditions. As can be seen on the attached charts over the last 12 months, Total Social Financing has averaged 3.92% of the PBOC's balance sheet, meaning that cumulatively, credit equivalent to 64.2% of the total PBOC has been issued over this period. As remarkable as this statistic is, it is actually slightly lower than during the period of massive bank lending following the 2008 collapse in a activity.

What is different this time around, is the expanded role of "shadow banking" (which we define as Total Social Financing - Total New Bank Loans). This has averaged 2.95% over the last 12 months, or a cumulative 35.35% of the PBOC's balance sheet. This is substantially higher than the prior peak of this metric seen in March 2010 when it registered 2.53% (30.36% cumulative) which helps explain the increasingly aggressive stance of the PBOC to shadow banking activity.

Our view remains that the deterioration in Chinese liquidity and credit conditions represents the most important macro trend for investors to follow at the present time and June's monetary and credit reports will be unusually interesting sets of data.

Japan's June Bank Loan and Deposit report shows a modest pick-up in lending activity and a more robust increase in deposits. This combination will be familiar to anyone who tracked the equivalent metrics in the US post 2009, since it generally takes a while until the new liquidity that has pooled in the financial system finds its way into new credit.

Although the blame for this lag is generally placed at the feet of the bankers, who are accused of refusing to lend, in our experience sluggish loan demand is at least as responsible. In part this is a product of understandable lag between an injection of liquidity and a consequent build up in confidence to consume, but also a reflection of the fact that with liquidity abundant lending is less required for the initial build up in personal and corporate sector activity since cash at hand is a viable alternative.

Certainly in Japan's case the latter is readily available, with June's report showing Total Deposits and CD's increasing 0.8% to ¥592.7 trln, a new record and an increase of 4.1% YoY, which is the fastest pace of growth since June 1999. This suggests that the massive increase of the monetary base is at least starting to affect private sector bank balances. Lending activity is growing more slowly, with June's data taking outstanding Bank Loans (ex trusts) up to ¥403.6 trln, an increase of 2.2% YoY.

As can be seen on the attached chart this takes the ratio of Deposits/Bank Loans up to 1.47, a new all time high (the equivalent ratio in the US is 1.285, up from 0.97 in late 2007). This ratio can be interpreted as the "latent potential" of the banking system to provide credit although as we discussed above it can take some time until its force becomes apparent in an economic cycle. In Japan's case, however, it should be noted that loan activity itself is far lower than it was 15 years ago, suggesting that there is little need for the private sector to deleverage, which means in turn that the lag between the build up of deposits and a pick up in lending may be somewhat shorter than was experienced in the US.

This morning's BLS report, and the fact that it was released on a relatively de-populated post holiday Friday, has led to a severe case of "belly ache" in the US Yield curve, with the 5 year Treasury yield rising by 13.6 bp to 1.55%. In looking at the yield curve in recent weeks we have consistently argued that this area forms the most dangerous portion of the curve, since post QE2 it has become dominated by leveraged trades attempting to benefit from the generosity of the FRB and even though QE3 targeted the long end of the curve this remained the case in recent months.

As our segmented chart of the US Yield curve shows, it is the 2-5 year portion of the curve (green) which has undergone the vast majority of the widening in recent weeks, with this spread moving from 55 bp in mid-May to 116.5 bp at the time of writing. This represents the widest spread seen since April 2012, just before the return of the Eurocrisis saw a flood of capital move back into "safe haven" treasury markets. By comparison the short end of the curve represented by the 1-2 year spread (blue) remains very tight at 24.3 bp, demonstrating that the market understands that the FOMC has no intention of raising the FDTR for a considerable period of time.

The long end of the curve has moved substantially higher in terms of actual yields, but its relationship to the middle of the curve is almost unchanged, with the 5-10 year (purple) spread range-bound at 112.5 bp. At the ultra-long end there has even been some compression with the 10-30 year spread (black) falling to 95.8 bp, its tightest level since November 2011 (when MF Global's liquidation was distorting all treasury yields).

Meanwhile this morning saw a significant change in the long end of US yields with the 30 year swap rate (see separate chart) moving back into positive territory for the first time since January 2009. The existence of a negative swap at the long end of the curve has been one of the great anomalies of this long period of ultra-low yields and we suspect this is further evidence of hurried liquidation of large long dated portfolios. We note that the negative swap spread started starting narrowing rapidly a couple of months ago, pre-dating the sharp move higher in long dated yields, and we would imagine that its move into positive territory implies more pain ahead for long dated bond holders.

The June BLS report would appear to have dealt a "Non Farm knockout" to the bond market, with this month's report underlining the solid improvement in employment data that has been apparent for several months in other data series.

The headline number for June estimated Total Non Farm Employment to have grown by 195K, once more beating consensus of 165K. This in itself in non-conclusive, given the volatility of the data but combined with sharp upwards revisions to April (now 199K, up from a revised 145K last month and the original print of 165K) and May (revised up from 175K to 195K), meaning that the last three months have averaged 196.3K during what is the hardest portion of the year from a seasonal perspective. This has caused the 12 month ma to rise to 191K which is equivalent to the pace of gains in June 2005 (when the FOMC was in the middle of a tightening cycle).

Private Sector gains (see chart) were estimated at 202K, compared to 175K consensus with May revised up from 178K to 207K and April from 157K to 188K for a 3 month ma of 188.3K. The 12 month ma of this metric is now 202K and it should be noted that the 200K barrier was not crossed last cycle until January 2006.

The more volatile Household Survey was less strong, with only 160K gains recorded and we note that this metric is now somewhat overdue a period of catch up with the more senior data. The Unemployment Rate, which is driven by the Household Report remained unchanged at 7.6% but the implications of the sustained improvement of Non Farm Payroll data (not to mention Initial Claims) are that a sharp drop in Unemployment will take place between now and the end of 2013.

Given the above the need for the Federal Reserve to continue to purchase long dated paper from an economic perspective is now indefensible. Of course the weakness in the bond market will now become the focal point of concern for the FOMC, with worries that higher yields will beget weaker economic data. Historically there really is little sense to this argument, and we continue to believe that the yield curve correctly changed its assessment of economic conditions and should continue to steepen regardless of FRB activity.

Japan's official Composite Leading Indicator Index rose strongly in May to 110.5, beating expectations for 101.2 while April's data was revised substantially higher from 99 to 107.7. The Coincident Indicator for May was 105.9 (96.2 consensus) and also saw April's data revised up from 95.3 to 105.1. This would suggest that Japan saw a more substantial reaction to the enactment of QE in the first quarter than was picked up in the original release, and that May saw a consolidation of these gains.

Although the current report is the strongest since June 2007 it should be noted that the data cannot really be compared across time periods, since the climax of the great 1980's boom generated substantially lower readings than the relatively tepid 2003-7 cycle. On the other hand for any given cycle the index has shown a robust correlation with the NKY index, indicating that it does have some merit. At the very least we would see the surge in this index as justifying the strong YTD performance in the NKY and we are not surprised to see that after pulling back sharply in May the index has consolidated and forced its way back above 14,000.

Link to interview

http://watch.bnn.ca/#clip958367


Interview focuses on US yield curve, crude oil, Europe and gold.

www.bloomberg.com/news/2013-07-02/rising-rates-tie-ivory-tower-types-in-knots.html

Another excellent editorial on this subject from Caroline Baum. We could not agree more with her comments.

Tomorrow's July 4th holiday means that we received a double dose of employment data this morning with both the monthly ADP Payroll report and weekly Initial Claims being released ahead of Friday's "big number".

Both reports confirmed the improvement in US employment data. The ADP report estimating 188K private sector job gains, ahead of 160K expectations while last months report was revised slightly lower by 1K to 135K. This caused the trailing 12 month ma to rise to 159.5K, its highest level since December 2012. We note that the ADP report has generally been weaker than the Non Farm Payroll report since its methodology was revised, with the average monthly report being some 25K lower since December 2011, although the volatility of both measures in no way guarantees that Friday's Non Farm Payroll report will exceed today's number by that amount.

Initial Claims by contrast have generally led the way in terms of improving data, and although this week's report of 343K was only modestly better than expectations of 345K it still represents yet another report below the key 350K demarcation line that divides a healthy and unhealthy employment market.

As to Friday's report expectations are for 165K Total and 175K Private Sector gains, together with an Unemployment Rate of 7.5% (down from 7.6%). All of this should be achievable but of course the BLS is capable of reporting almost any number in an individual month. We would imagine that the market would be "surprised" by any gains above 200K or below 150K but given the likelihood that trading desks will be sparsely populated on Friday it may take until Monday for the effect of the report to be fully digested.

This week's MBA Mortgage Application report continues to suggest that home purchase activity has been unaffected by the recent rise in US interest rates and that ARM activity is starting to become a significant portion of total activity.

As would be expected refinance activity has been dramatically curtailed, with the Refinance Application Index falling to 2568, its lowest level since July 2011 (when the Debt Ceiling debate was pushing long term yields higher). The Purchase Application index on the other hand dropped to 208.20, comfortably withing its recent range and keeping its 10 week trailing ma at 212.84, just below its level of last week. This means that Refinance applications represented 64.3% of total applications last week, the lowest proportion since May 2011.

Regarding the type of mortgages used although the 30 year fixed mortgage continues to dominate there has been a marked pick up in the use of ARMs, with the percentage of application rising to 7.5% of volume and a significantly higher 15.5% of value. As would be expected it is the buyer of more expensive homes that is most likely to switch to an ARM but both metrics are now at their highest level since July 2008. Given that ARM usage remains well below its historical normal level we would expect to see a significant shift towards this type of product should the recent rise in interest rates prove to be long lasting, and this would be a key enabler of the housing recovery extending as the overall economy gathers pace.

Despite the fact that June witnessed a sharp increase in medium and long term bond yields US New Car sales reached 15.89 mm units on a SAAR basis, the highest level since June 2007 and an increase of 11.1% from June 2012. The trailing 12 month ma of sales has now moved above 15mm for the first time since July 2008 and this metric should continue to rise substantially through the rest of 2013. We note that pre-crisis car sales were generally contained in a range between 16mm and 18mm units and averaged 16.75mm units between January 2001 and December 2007.

This suggests we still have a little more upside until car sales normalized, however, when one takes into account the fact that total sales over the last 5 years have averaged 12.53mm cars this means that a demand shortfall of over 17mm units (or a good year's total sales) took place since the summer of 2008. Given the substantial aging of the country's car fleet that resulted from this down-shift in sales it is therefore possible that for a period of time sales could actually force their way above the "normal" range, meaning that there is potentially a little more potential upside in future activity than may appear to be the case.

At the very least we would expect to see sales very stable around the prior average, but the possibility of a few quarters of above average sales should not be ignored.

For the second month in succession Spain reported a substantial drop in unemployment that goes well beyond the seasonal pick up in tourism related activity. The total Registered Unemployment Level fell by -127.2K in June, beating expectations for a -100K drop and the largest single monthly drop since the data starts in 1996. This takes the trailing 3 month ma down to -90.5K, which is the greatest ever average drop in the data underlining the strength of recent reports. Although the trailing 12 month ma remains in positive territory at +12.4K, this is the smallest rise since June 2011 and this metric should now fall into negative territory once some of the larger 2012 rises fall out of the calculation.

Of course Spain's Unemployment Level has reached a remarkably high level before this improvement took hold. Peaking at 5,040K in February 2013 up from 2,075K in February 2007. As debilitating as this degree of idle labor is for the economy at least this suggests that further sharp improvement can be anticipated now the cycle looks to have turned. We would note that seasonal factors will make it hard (but not impossible) to post negative months (ie net job gains) from August through January (see seasonal table) but we would expect to see much fewer job losses in the fall and winter than would typically be the case.

Italy's June Car Registration data suggests that the three year draw down in local car sales may finally be approaching a bottom, with total sales of 122K representing a drop of -5.5% from the level of a year ago. Obviously this is not as encouraging as a positive report but given that we had seen new car sales fall at a -20% annual rate over the course of 2012 this does represent something of an improvement, and although the trailing 12 month ma is still -15.55% YoY we would expect to see this metric rise quite quickly going forwards.

In terms of actual activity the last 12 months have seen an average of 109.4K registrations, the lowest level of activity on record (the data starts in 1981) and about 45% lower than the pre-crisis level of sales. This is comparable to the degree of demand destruction that we saw take place in the US between 2007 and 2009, since which time demand has risen back towards about 85% of pre crisis sales. It is not clear if Italy will benefit from the same type of rapid recovery and of course the data has yet to definitively bottom but we would expect eventually to see a decent recovery in sales given the cyclicality of this particular industry.

We have always counted the monthly ISM Manufacturing Survey as one of our favored metrics but we cannot help but feel that PMI reports in general have become a little "over watched" in recent quarters, with relatively trivial fluctuations around the neutral level generating disproportionate reactions by observers.

Since we are dealing with a "diffusion index" a reading just below or above 50 really just indicates that no substantial change took place from the prior month. In the middle of an economic cycle this is neither surprising or damaging since really this indicates that a clear trend of improving conditions have been established. We were thus unmoved by May's disappointing 49 headline reading and are not very excited by the fact that this improved to 50.9 in June, although we recognize that in the process a large "macro worry" will have been removed from the marketplace.

The sub indexes have been a little more volatile, with poor May data being replaced by better June reports in almost all cases. New Orders (red) rose to 51.9 from 48.8, Production (blue) to 53.4 from 48.6, Inventories (olive) to 50.5 from 49.0 while Employment (pink) fell slightly to 48.7 from 50.1. In other words June was a solid report that suggests that no interruption to the long improvement in Manufacturing conditions took place in the second quarter.

Japan's Tankan Survey (a quarterly equivalent of the ISM Manufacturing report with a similar length of history) shows a marked improvement in sentiment amongst Large Manufacturers, with the Q2 Outlook survey reading at 10, its best since Q4 2007 and up from -10 at the end of Q4 2012, before the BoJ's shift in policy became well understood.

Given the sharp devaluation of the JPY since the start of the year, and the importance of exports for Japan's larger industrial concerns, this surge in confidence is unsurprising, but it is always good to have reports like this confirm the strength of the change in sentiment. Looking at the history of this data series it would take a move above 20 to really suggest that strong economic conditions are taking hold, and at the current pace of improvement this is a realistic target for the end of the year.

The mood amongst Small Manufacturing remains much downbeat, with the Q2 survey remaining in negative territory at -7. As can be seen on the attached chart The "Tankan Small" survey has a history of much lower readings and has spent almost the vast majority of the last 21 years in negative territory. Even at the height of the last economic cycle struggled to reach 9 in Q1 2006 (at which time the "Tankan Large" reached 22). A reading of -7 is therefore actually quite encouraging and represents the best report since Q4 2007.

We note that the Present Conditions index remained at -14 suggesting that the respondents are starting to see signs of improvement that are yet to materialize into actual order flow. Given that this portion of the economy has benefited much less from the JPY's depreciation it will be much more dependent on a rebound of domestic demand and should the Tankan Small Outlook survey manage to make the transition into positive territory later this year it would be a useful piece of anecdotal evidence that a meaningful recovery is taking place.