Brazil's fiscal position continues to erode steadily as costly government intervention runs ahead of tax collections. September saw a Nominal Budget Balance of -22.9b BRL, somewhat wider than the -19.3 bln anticipated. The primary cause was a very wide Primary Budget Balance of -9 bln (0.5 bln surplus expected) which was driven by an early pay-out of social security benefits, which one assumes will be followed by reduced expenditure later on this quarter. On the other hand the interest expense was about 6 bln BRL less than anticipated, which can be expected to be reflected in a future increase in expenses.

Whatever the specific issues in September's data were what cannot be denied is the clear deterioration in the trend of data. Over the last 12 months the cumulative nominal balance has dropped to a deficit of 155.5 bln BRL, compared to a level of 120.7 bln BRL a year ago (see chart) as the Primary Surplus (which excludes interest payments) has shrunk and interest costs have risen. YTD the deficit now represents -3.77% of GDP, the widest level seen since October 2009 when the data was greatly affected by the 2008/9 collapse. Should the deficit finish the year at this level it would represent the largest proportion of GDP since 2003 (see chart). Although a deficit of this degree is arguably sustainable it leaves little margin should a further slowing of economic activity pull tax receipts lower.

Ireland's Live Register of unemployed persons continues to drop rapidly from a very elevated level. October's data showed a -3.7K decrease, the 15th consecutive month of decline and the 12 month reduction has now reached -24.3K, the largest annual drop since April 2001. The register now lies at 409.9K, the lowest level since June 2009 although it remains far above the 150K level that was typical before the financial crisis. This at least means that further rapid progress can be anticipated going forwards and we would hope to see the psychologically important 400K level breached this quarter.

Interestingly there has been a much faster drop in youth unemployment in Ireland in recent months, with the Under 25 category falling to 64.4K, its lowest reading since November 2008. This takes this category's percentage of the total down to 15.1% (see chart) which is a record low since the data commenced in 1980. We suspect in part this very rapid decline is a result of increased labor mobility in the EU, allowing the younger population to look elsewhere for work opportunities. Although not without its social consequences this is a reminder of how some of the economic reforms enacted over the last 20 years have helped Europe craft a recovery in recent months.

Although emerging market currency markets have stabilized in recent weeks the fundamental deterioration of trade balances in a number of countries continues to point towards future vulnerability.

This morning saw the publication of September trade data for Turkey and South Africa, with both countries posting wider than expected deficits. In Turkey's case the trade gap widened to $7.5 bln, compared to consensus estimates of -$7.3 bln and September 2012's level of -$6.8 bln. This continues the eroding trend for Turkey's trade position, with the 12 month ma falling to -$7.88 bln, its lowest level since May 2012.

South Africa's deficit is considerably narrower at -18.9 bln ZAR (approximately -$1.9 bln) but the trend of deterioration is equally marked. Consensus called for -16.4 bln and a year ago the deficit was -13.8 bln. As recently as 2011 South Africa posted an annual trade surplus, compared to the current 12 month ma at -13.4 bln ZAR. The danger remains for both countries that any slowdown in capital inflows (let alone an actual resumption of the sort of outflows seen at the end of Q2) will start to place further strains on currency markets.

The Japanese housing market continues to show signs of accelerating activity with September housing starts reaching 1.044 mm units on a SAAR basis, well above expectations of 983K and August's 960K reading. This represents a 20.6% increase in activity YoY and takes the trailing 12 month ma up to 950K, its highest level since May 2009. A look at the NSA data confirms the strength of this report with the monthly total of 88.54K starts representing the strongest single month since October 2008.

Although we realize that some of this surge in activity has been caused by a rush to beat the proposed increase in sales tax in 2014 the strength in the data is not restricted to housing being built for sale but is also present in the rental data. This increased to 32.1K in September, an increase of 21.2% YoY and the strongest monthly data since January 2009. The fact that rental activity is also recovering strongly suggests that this is more than a rush to beat the tax-man, and that the Japanese housing market is finally recovering from 5 years of torpor.

After the major re-write of the FOMC statement at September meeting the text of this afternoon's release contains comparatively few changes, reflecting the fact that the decision to defer any reduction in bond purchases last month was always likely to be a multi-month affair. In addition the government shutdown meant somewhat less official data was available for perusal and those reports that were released were (even) less reliable than normal.

We have attached a red-lined version of the text (courtesy of Bloomberg ©) and as can be seen the majority of changes take place at the start of the communique. The outlook for the housing market was downgraded a little but perhaps the most interesting linguistic choice was to remove the controversial reference to the "tightening of financial conditions" as a risk to the recovery that was included last month.

There were three explanations offered by observers to the use of this term last month:

1. Ignorance

2. Conflation of Financial Conditions with the general level of interest rates (we note that the Chicago Fed's Financial Conditions Index contains a large input from underlying interest rates see link http://www.chicagofed.org/webpages/research/data/nfci/background.cfm ).

3. An implicit signal that the FOMC had been influenced by the (genuine) deterioration of financial conditions in a number of key emerging markets.

If we remove #1 as both impolite and highly unlikely given the large number of FRB staff who are paid to sit around looking at data, the remaining two explanations (which are not mutually exclusive) do offer an insight into the degree of the task that the FOMC has taken upon itself.

Over-emphasizing the significance of treasury yields removes the concept of a "benign" rise in interest rates, with no differentiation being made between a rise in treasury yields that steepens the curve and compresses credit spreads (even if nominal credit yields still rise), and one which is driven either by a sharp increase in short term yields and flattens the curve, or a rise of credit yields in which treasury yields either remain the same or actually decline. The first scenario is actually the typical back-drop for a strong economic recovery, the second for the period in which a central bank is adjusting policy to bring it into line with reality and the third a sign that monetary conditions are inappropriately tight. Under the Bernanke Doctrine instead we have a steadily strengthening economy with depression level treasury yields and relatively high credit spreads.

Regarding the influence of events within emerging markets we note that the extension of the FOMC's mandate into the international sphere arguably commenced in 2008 with the launch of the CBLS (a large scale provision of USD swap lines to a number of key EM central banks) and that this facility was used on a smaller scale in late 2011 to help the ECB control USD pricing at the height of the Eurocrisis. Nothing as dramatic took place over the summer months but the notion that the decision to maintain full bond purchases because of the stresses encountered in countries such as India and Brazil is somewhat surprising. Nevertheless the strains felt in financial conditions of emerging markets were clearly discussed in the truncated minutes of the September meeting and our assumption is that they were a factor in the decision to keep the current level of bond purchases in effect.

The removal of this language regarding financial conditions may therefore be an indication that the FOMC received some criticism over this issue or may instead reflect the fact that interest rates came back down in the US and most emerging markets have recovered a good portion of their summer losses. However, the fact that they did not choose to state that financial conditions have recovered but instead simply deleted the reference to them makes the former explanation a little more likely.

The rest of the text remains almost unchanged, with the promise that bond purchases will remain in place for a while longer and that the gap between tapering and an actual rise in interest rates will be lengthy. We continue to take issue with the latter, since we believe that the FOMC continues to underestimate both the speed with which employment conditions are improving and inflationary pressures are building. We do not doubt the honesty of the committee, merely its ability to accurately gauge the trajectory of an economic cycle which has consistently surprised it.

FOMC Statement Oct 30th 2013

The Lloyds Bank Commercial Business Barometer is a survey conducted with over 200 of the banks commercial customers tracking both current economic conditions and expectations. It is a diffusion index (in other words it records monthly improvement or deterioration rather than absolute levels) with the headline number representing the net percentage of positive or negative responses.

October saw the highest ever positive reading for the Current Conditions index at 63 (made up of 72% improving and 9% deteriorating), which represents another metric pointing to a robust UK recovery. This is the 14th consecutive positive reading and the 12 month ma of this metric has now reached 34, a level only surpassed during the initial "V" shaped rebound from the 2008/9 collapse.

Although this index tells us little about the absolute level of conditions we suspect these are fast approaching "normal" for many businesses and perhaps surpassing that in stronger areas of the economy. This clashes with the UK treasury market which still maintains a 10 year yield at a recessionary 2.56%, and monetary policy which combines a record low Base Rate with significant asset purchases.

Given the strong momentum in UK economic data we are starting to suspect that the UK treasury market could be the first to decouple itself from global markets by moving higher in response to strong economic data and that the BOE may be the first DM central bank to break with with the "Bernanke Doctrine" (we would expect the former to lead the latter) although it would probably take a clear upsurge in inflation data to cause the latter to take place.

Since the BLS employment report will not be released until the 2nd Friday of November this morning's ADP National Employment Report will perhaps have a little more time in the limelight than usual. The data showed an estimated 130K jobs added in October, below consensus expectations of 150K. However, given the natural volatility of this series and the fact that October activity will have had some impact from the Washington stand-off most observers will treat this as an in-line report (as can be seen by the limited response by US treasuries).

This keeps the 12 month ma almost unchanged at 172.1K, which remains about 18K below the average monthly level estimated by the BLS over the same period. We note that since its recalibration last year the ADP report has been consistently reporting lower numbers than the BLS. We do not ourselves favor one over the other from a methodological standpoint (they are both deeply flawed as real time signals, but more useful as longer term indicators of employment trends) but we would take into account the ADP reports consistent "under-reporting" of payroll gains when interpreting the data.

The after-effects of the government slowdown were clearly evident in the Conference Board Consumer Sentiment Index, which fell sharply to 71.2 in October from 80.2 in September (revised up from 79.7). Although this was somewhat lower than expectations of 75 given the clearly understandable cause of the decline it is hardly a cause for concern.

Indeed a similar wave of disgust followed the Fiscal Cliff debacle last January, when the index fell to 58.40 from 66.70. This didn't alter the trajectory of confidence which has been slowly building since the collapse of 2008/9 and by February the index had risen as high as 68. Given the transitory effect of the shutdown we would expect to see a similar rebound in confidence next month.

Perhaps the most interesting aspect of consumer confidence this cycle has been how muted it has been in the face of a strong bull market. October's poor reading was notable for taking place against the backdrop of the SPX forcing its way up to a new all time high (in January the SPX was recording a new six year high). Current levels of confidence are equivalent to that normally seen at the early stages of a bull market rather than the sort of giddy belief that accompanies major market tops.

The PBOC released its September 2013 balance sheet last night and although the data contains few surprises it acts as a reminder that credit growth continues to massively out-pace that of the monetary base. Total Assets grew by 226.5 bln CNY (0.73%), taking the annual growth rate down slightly to 7.43% from 8.02% last month. This represents something of a loosening from the static balance sheet of late 2012 but also a much tighter level of liquidity creation than we saw for much of the prior decade. In other words the PBOC has grown its balance sheet at very close to the stated target for GDP in recent months, perhaps a sign that the monetary base itself has become a key policy tool.

Of course credit growth can diverge from monetary growth for long periods of time (and in both directions as the FRB has discovered over the last five years). The official bank loan sector has been growing at over twice the pace of the central bank in recent months, while the shadow banking system has added an equivalent amount of credit into the system.

The two metrics we use to track this are the 12 month ma of total Social Financing compared to the size of the PBOC's balance sheet. This currently reads 4.99%, meaning that over the last 12 months total credit created has been equivalent to 60% of the PBOC's balance sheet (see chart). Although this is slightly lower than the readings seen in early 2013 it is still a remarkably high level, particularly since it follows the blowout readings of 2009/10.

We also track the ratio of the PBOC's balance sheet to total bank loans, and this fell to 0.4428 in September, the lowest level since October 2004. Of course nine years ago non-bank credit was a fraction of its current level, meaning that this ratio significantly underestimates the change in the relationship between total credit and total liquidity in the Chinese economy, although its direction remains an accurate reflection of the change in conditions.

Brazil's loan data for September hints at a moderation of lending by the State Sector banks, whose outstanding loans grew by 9.37 bln BRL (0.72%), the second slowest month since February 2012. Indeed for the first time in several quarters Private Sector bank lending grew by a larger amount, increasing 10.54 bln BRL (0.83%) but it is too early to be sure if this represents a change in the lending landscape or simply a one month blip.

Any slowdown by the state sector would be significant, since over the last couple of years this has been the dominant source of lending in the Brazilian economy, with a YoY growth rate of 26.5% compared to private sector lending growing at a 6.5% pace. As the attached chart shows this allowed the state sector to overtake private lending over the summer for the first time in modern history. We have voiced concern that this politically inspired growth has come at the cost of underwriting quality, with state banks apparently willing to extend credit in a manner that private banks had little appetite to match.

In terms of the sector breakdown there was little to report in the September data, once again Housing remains the most important driver of credit growth. Personal Credit grew by a modest 2.9 bln BRL (0.39%), while the delinquency rate of Personal Credit remained steady at 7.00%. With the unemployment rate now easing up and the credit growth rate slowing down we doubt whether much more progress will be made by delinquencies going forwards, and would not be surprised to see an up-tick in problem loans by the middle of next quarter.

The RBI acted in line with expectations last night, raising the REPO cut-off yield by 25 bp to 7.75%, its level between February and March this year, tightening monetary conditions for a local economy which is approaching stall speed. At the same time some relief was given to the financial sector, with the marginal standing facility rate (used by banks to access short term funding) dropped to 8.75% from 9.00%, which in turn eased some of the pressure on the local money market. Interbank rates now vary between 8.98% (overnight) and 9.22% (3 month) and while these levels are significantly higher than those prevailing earlier this year they also represent a big improvement from the "crisis" readings seen in August and early September.

The equity market liked these steps, with the SENSEX rallying 1.74% to close at 20,929, its highest close since November 2010. Including these gains the index is only up 7.73% YTD in local terms, and down 3.96% for a USD investor, underlining the substantial under-performance of Indian equities in recent months.

International investors remain very patient with Indian equities, with YTD flows recovering over the summer to reach $15.7 bln, above their May peak. Interestingly bond investors are acting very differently with total YTD outflows hitting -$7.9 bln, by far the largest removal of foreign capital on record. We assume this discrepancy has been caused by the substantial losses in the INR, which are of course much more problematic for bondholders (with fixed yields) than equities. This removal of capital has acted to further tighten monetary conditions, with bond issuance slowing to a trickle in recent months.

India to our eyes remains vulnerable to further economic deterioration, with high inflation and large fiscal and trade deficits. We do not deny that some progress has been made in terms of restoring market confidence in recent weeks but the problems remain daunting and the corporate opportunities rather more limited than across most of the developed world.

Ireland's housing market continued to experience a strong rebound in prices in September with the National Residential Price Index rising 1.8% MoM, its largest monthly rise since August 2006. This is the sixth successive monthly price gain and takes the annual gain up to 3.6%, its highest level since late 2007. Of course the actual level of prices differs greatly from 6 years ago, with the index reaching 68.2 in September, almost exactly half its peak value in the last cycle.

The key Dublin market continues to set the pace for the rest of the country with prices gaining by a record 3.9% in September and 12.3% YoY, the fastest annual pace since April 2007. Again we would note that prices are only 49% of their prior cycle peak, but even so this is a very rapid pace of repair that indicates a strong resurgence of demand for housing in the nation's capital.

The US Pending Home Sales report showed a surprisingly steep decline in transactions with the seasonally adjusted index falling from 105.8 to 101.6 when consensus had called for a flat report. This takes the index back to its level in late 2012, which while disappointing as a monthly report still represents a reasonable level of overall activity (January 2001 activity = 100).

If there is any solace to take out of report it is that the collapse in activity took place in September, which is seasonally much less important than the prior 4 months, each of which saw Pending Sales record multi-year highs (ignoring tax credit distortion). Thus the number of "lost" transactions is far smaller than would have been the case with a 5% draw-down in July or August, although its effect on the seasonally adjusted headline is the same (see charts).

We would also note that monthly draw-downs of this magnitude are not unknown during strong housing markets with August 2003 seeing a similar decline (down 5.2 points to 108.1), again following a steep rise in mortgage rates (the 30 year mortgage rate rose from a then record low 4.90% in mid-June to 6.10% at the start of August). We therefore would not read too much into this data other than confirming the fact that higher rates did alter buyer behavior this summer, with perhaps some purchases being rushed through in an attempt to lock in rates that we feared to be rising further.

A decade ago the housing market was to accelerate into a bubble despite the fact that the 2003 low in mortgage rates was not surpassed again that cycle (it took the economic collapse of 2008/9 to achieve that) and our view remains that the stresses caused by rising rates will prove to be transitory this time around as well. There is nothing unusual about a housing cycle pushing against the twin headwinds of rising prices and interest rates, and while sharp moves in either can alter the trajectory of recovery (particularly over the short term) they do not typically force market activity to trend lower until housing affordability becomes truly problematic.

Since there was little new data released overnight worth commenting on we will revisit an issue that garnered an awful lot of attention a few months ago, but now seems to have slipped off radar screens, namely the very rapid build up of NYSE margin debt that has taken place since the start of this powerful bull market.

Readers may recall that over the spring and early summer a large number of stories were written, sparked largely by the simple fact that in April outstanding NYSE margin debt had risen to a new all time high, breaking above both the level seen in at the March 2000 ($279 bln) and July 2007 ($381 bln) highs, each of which took place against a peaking bull market. The fact that outstanding NYSE margin then went on to post a modest 2% decline in May led some to conclude that the top for debt was in place and that the US equity market was likely to suffer a significant decline within a number of weeks.

We were resistant to this view at the time, and pointed out that although NYSE Margin debt and the US equity market do tend to peak within weeks of each other (for obvious reasons) there is nothing unusual about a long bull market taking margin much higher than its prior peak. Indeed making a new high in margin has normally been nothing more than an intermediate step along the way (see attached long term chart).

A few months later we can see this pattern playing out in the US, and after the spring hiatus we note that the last 3 months have seen a rise in outstanding margin, with September's strong rally being partly fueled by a robust $18.3 bln increase (4.78%) to a new record high of $401.2 bln. No doubt this new record will make some queasy, with the mantra that this build up is unsustainable and that it undermines the credentials of this bull market.

We beg to differ. The rapid rise in margin debt is a logical outcome of both the robust equity market (which has good fundamental underpinnings) and the very generous monetary conditions kept in place by the FRB. The effect of the latter is twofold, with both the price and quantity of money being radically altered and as we argued in the summer the sustainability of a credit surge is ultimately dependent on both these factors.

Regarding price, NYSE Broker call is the base rate for margin debt (borrowers will either pay a premium or receive a discount according to their credentials). Using this a a proxy for cost we can see that the total interest burden of current outstanding debt is $8.024 bln, less than a third of the July 2007 level of debt service at $26.695 and about 2.5 times less than the March 2000 level of $21.6 bln.

Regarding the quantity of money if we use M2 as a rough proxy we can see that the margin debt is currently 3.7% of total money stock, compared to 5.2% in July 2007 and 5.9% in March 2000 (we would see something similar if we used total bank deposits instead). In other words the current rapid build up of margin debt is actually quite sustainable, and moreover is likely to be sustained (which is not quite the same thing).

This is not to say we we welcome or applaud this process, but ultimately we are meant to be pragmatic observers (and participants) in the various investment cycles we encounter, and not fall into the moralist trap of bemoaning the perhaps less welcome consequences of a very powerful bull market.

Link:

www.bloomberg.com/video/bond-market-extremely-expensive-shaoul-says-oBBKkO3vRJa3vj1aum2eRA.html

Interview focuses on the relative value of the equity and bond market.

Attention towards Japan has become much more muted in recent months, in part because the torrid gains of early 2013 have been replaced by a duller range-bound market, but also because actual policy reform has proved more muted than some had hoped for.

We have always viewed the story differently, with monetary policy being the primary driver of our investment thesis together with an appreciation that Japan's primary motivation in following this reform is not economic but instead political. The country (or at least the newly elected administration) fears its economic irrelevance on the global scale is starting to become a diplomatic and even military handicap, a point made clear in the publication of its 2013 white paper on defense:
See link http://www.mod.go.jp/e/publ/w_paper/2013.html

For this reason we do not doubt the determination of the BoJ to see this policy through, and we are always great believers that given enough time monetary policy has extremely powerful effects. Fiscal reform and deregulation have a much spottier record, and while progress in either area would be a plus they are ultimately less important than the radical boost to domestic liquidity being undertaken by the BoJ.

One sign that this liquidity injection is having some effect is the turnaround in national CPI. This grew 1.1% YoY in September, the fastest annual pace since October 2008 (when soaring global oil prices rather than monetary policy were the catalyst). This compares with a -0.3% level a year ago, suggesting an important turning point in the inflationary cycle may have been delivered. The 12 month ma remains slightly negative at -0.1%, but this reflects data produced in late 2012 and early 2013. Monthly prices have increased every month since February and this slower moving metric can be expected to move into positive territory soon enough. Whether a trend towards higher prices can be sustained remains to be seen, but the fact that we have now moved into positive territory without any significant attention is an interesting development.

After the SHIBOR scare of early July China has had a relatively quiet summer, with most observers concluding that steady growth had resumed in the world's second largest economy. Our view over this period has been more nuanced; we recognized that the spike in concern was probably premature, but the scale of difficulty in navigating economic policy between the inflationary impulse of the local housing market, and the deflationary forces present elsewhere made it highly likely that China would be a source of market tension going forwards.

We therefore note with interest that both the local SHASHR index and offshore HSCEI index would appear to have de-coupled from the general recovery in emerging market equities in recent days, with both indexes falling below important support at their 50 day ma's. Interestingly this has been in part a response to another spike in money market rates, which have risen right up to the top of their normal range and are now threatening to break higher.

As was the case in July, the cause would appear to be a deliberate draining of liquidity from the REPO market by the PBOC. This follows the general pattern of the last two years in which credit has remained abundant (increasing in total by approximately $3 trn over the last 12 months) while actual liquidity available to the banking system has been much tighter.

It remains to be seen whether this episode will be allowed to proceed any further, or if the PBOC will start to add liquidity quickly to the money markets, but either way it is a reminder that China's capital markets remain in much more fragile state than those in the developed world.

Link to interview:

http://watch.bnn.ca/#clip1030291

Interview concentrates on equity and bond market comparing risk and opportunity in both.

We have always valued the weekly Initial claims report as giving a useful real-time snapshot of labor markets. It is therefore unfortunate that a combination of the government shutdown and computer problems in California (which is by far the largest state for this data) have served to distort reports since mid-September.

This week's report showed Claims of 350K, above estimations of 340K (for the reasons given above consensus was derived from an unusually wide dispersion of estimates), while last week's data was revised higher to 362K. This took the 4 week ma of Claims back up to 348.3, compared to a reading of 305K on September 27th, a number which was partially lowered by back-logged Californian claims which are now flooding the system. A sense of the scale of this issue is that during the summer California typically accounted for around 16% of total national Claims, and 13.6% of Claims for the week ending October 6th 2012, but supplied almost 24% in last week's report, suggesting that around 25-30K of total Claims were caused by the backlog.

Interestingly even with the impact of California and the Federal shutdown (no estimate was provided at the impact of the latter) the 4 week ma has only backed up to its level in July. Since both these issues will only have a temporary effect on the data this still suggests that a marked improvement in Claims took place over the summer, although perhaps not quite as significant as the giddy data released in early September. We will not have a reliable read on Claims data for a number of weeks but we would expect to see Claims settle somewhere between 300K and 320K sooner or later.

We would remind readers that this improvement has not been reflected in the relatively poor non-farm payroll data released since July, suggesting that some degree of catch-up is due by the latter. Of course the October non-farm payroll report will have to adjust for the Washington hiatus but sooner or later we would expect to see some significant upside employment reports.

http://blogs.wsj.com/economics/2013/10/23/dont-put-too-much-stock-in-one-jobs-report/

A very sensible piece that outlines the degree and sources of volatility in this over-watched data series. Well worth reading as a general reference piece.

The Brazilian Consumer Confidence index fell to 111.70 in October, a 2.5 point drop from its September level despite the recovery in the local equity market. As can be seen on the attached chart this keeps confidence towards the low end of its recent range, although it remains over 3 points higher than its July 2013 low of 108.3, which coincided with the abrupt sell off at the start of summer.

However, even that July reading could hardly be seen as the sort of deeply pessimistic reading that marks the end of a bear market. Even allowing for the natural optimism of Brazilian consumers we would expect confidence to be comfortably below 100 at the down point of an economic and market cycle, and we note that this measure was breached between October 2008 and April 2009, with the low point being 94.9 recorded in November and December.

The reason for the resilience of confidence is not hard to fathom, since the local government has done everything within its power to ensure that the pain of Brazil's economic slowdown has been felt by the corporate and investment sectors rather than Brazil's consumers. Unemployment has remained very low (partly because of Brazil's rigid labor laws that make lay-offs very difficult) and credit has continued to be freely available (aided by the generosity of the state controlled banks late into the economic cycle). Thus although confidence has lost the buoyancy of the boom years it remains far above a recessionary level.

Our view is that this is unlikely to remain true throughout the remainder of the down cycle, and that at some point significant pain will be felt by Brazil's consumers, and will be reflected by a sharply lower confidence reading. Paradoxically this outcome would signal better news for investors, since a few months of low confidence readings would be consistent with the bottoming of the down cycle. As it is we are not there yet and we would avoid the temptation to step back into Brazilian equities (particularly those focussed on local demand) at the current time.

UK mortgage approvals for September totaled 42.99K, well above expectations of 39.5K and the strongest single month for transactions since December 2009. This represents a 39.6% YoY increase in activity for September's single month data, and while this may overstate the underlying trend of improvement the 12 month ma has now recovered to reach 35.19K, its highest level since October 2010.

However, this does not tell the entire story; because home prices (particularly in London) have recovered meaningfully in recent quarters the value of approved transaction actually broke out to a 5½ year high in September of £6.666 bln, underlining the significance of this recovery to both the UK consumer and banking sectors. The 12 month ma of this metric rose to £5.456 bln, the highest level seen since July 2010, but if September's breakout can be sustained this metric will start to climb strongly into the end of the year.

One of the few silver linings to the Washington shutdown was the fact that we were saved the release of much of the government economic data but this morning saw the return of a dark cloud in the form of the September non-farm payroll report.

This data series has in recent months shown no obvious sign of improvement in contrast to a host of other employment metrics from both the public and private sector that suggested (at least through September) that the last 6 months have seen a notable uptick in labor demand. Unfortunately, the non-farm payroll report remains the "daddy of the data", setting the mood of the market (at least over the short term) and the terms of analysis within the Federal Reserve, despite the fact that there is no evidence that it supplies a more accurate reflection of current conditions than alternative measures such as Initial Claims.

The September BLS report estimated Total Additions to Payrolls at 148K, below expectations of 180K. August data was revised higher to 193K from 169K while the weak July report was revised lower from 104K to a scarcely credible 89K. Including net revisions of +9K this takes the data to within 25K of the consensus view, which is of course well within the error tolerance of this data. In other words whatever the immediate effect on the market's psychological make up there is little conclusion to draw from the data.

Private Sector Payrolls were estimated to have risen by only 126K, compared to 180K consensus. Hidden in this "miss" is the fact that the Public Sector has ceased to be a drag on overall employment - a notable change from the first four years of this recovery. Revisions to the last two months were -18K, taking the overall picture a little lower. On the other hand the trailing 12 month ma actually rose slightly as the poor September 2012 data dropped out of the calculation, with this metric now 191K. As can be seen on the attached chart there has been remarkably little change to the annual pace of job gains over the last three years, which is as good an argument as any for paying somewhat less attention to the monthly reports.

It is also interesting to note that the clear trend of improving Unemployment remains in effect, with the data falling to 7.2%, helped by a 133K gain on the Household Survey (the Participation Rate was unchanged at 63.2%). This takes this metric a little closer to the FOMC target of 6.5%, although we note that the committee has sought to distance itself from rigidly responding to this guideline in recent meetings.

In the normal course of a year we would expect better data to be released during Q4, which has significant seasonal tailwinds helping the report. This time around we will have the distortion from the shutdown to contend with, making the October and November reports even more of a lottery than normal. Our advice would be to simply move on from today's report and assume nothing major has changed, with perhaps the most important effect being that the bond market may have bought itself a little more time.

China continues to experience a broad housing boom which is unsurprising given that credit metrics continue to suggest a very rabid build up of private sector indebtedness.

September's data showed New Affordable Home Prices rose in 65 out of 70 surveyed cities (falling slightly from 66 last month), with only 2 cities experiencing falling MoM prices (unchanged). Existing Home prices rose in 63 cities (up from 58 last month) and fell in only 4 (5 last month), which is the strongest data seen since April at the start of the brief crackdown in shadow banking.

It is not just the consistency of the data that is remarkable but also the rate at which prices are increasing. Beijing (16%), Shanghai (17%), Shenzen (20%) and Guangzhou (20%) all experienced very sharp annual price increases in markets that were already fully priced a year ago. It remains to be seen at what point the PBOC will feel forced to react to this situation, but the fact that other portions of the Chinese economy (most obviously exports) would appear to be growing well under the GDP target rate, the temptation to allow a buoyant real estate market to continue to carry the strain would seem to be winning the policy argument.

Link:

www.bloomberg.com/video/s-p-500-can-hit-1-800-by-end-of-the-year-shaoul-Af81HuE6TkiUT9OX368xdA.html

Interview concentrates on US equity and bond market.

September's NAR report on Existing Home Sales showed a stabilizing of the housing market following the strong recovery of activity over the last two years. Total Sales were estimated at 5.29mm units almost exactly matching expectations, with August revised slightly lower to 5.39mm from 5.48mm units. This still keeps activity over 15% above its level of a year ago, while the trailing 12 month ma has risen to 5.06mm, its highest level since November 2007.

Activity in Single Family homes matched the overall picture with sales of 4.68mm representing a 10.9% YoY change, and the 12 month ma also reaching a 6 year high at 4.47mm units. In other words a strong trend of recovery has taken hold which has lifted the overall market back to a level equivalent to that of the healthy pre-boom housing market at the start of this century.

One slight change is the state of inventory which registered its first YoY rise in over two years. The rise was a modest 3.7% and at 1.96mm units overall inventory remains very low. However, it does now look as if the inventory cycle has finally bottomed with the 12 month ma flattening out at 1.82 mm units, the lowest level for this metric since December 2001. It should be noted that a rising inventory from a low level is quite normal for a strong existing home market, particularly if it reflects a willingness of homeowners (or lenders) to list houses that have seen prices recover back to where they can be sold for an acceptable sum. Indeed given that activity in certain markets has been held back by the availability of units it would not be a surprise in inventory and sales start to be positively correlated going forwards. Much later on inventory may become a sign of a housing market in over-supply, but we are nowhere near the sort of metrics seen at the peak of the last two housing booms.

Over the last few years the Bank of Israel has had close informal ties to the FRB thanks to the fact that its Governor Stanley Fischer had served as the doctoral supervisor to Ben Bernanke. Strangely enough their succession has also been tied by history, since in both cases an internal female candidate that they preferred (we state this without hard proof in the case of Chairman Bernanke favoring Janet Yellen) seemed about to be passed up in favor of a political insider with close links to the President/Prime Minister.

Most readers will be aware of the ill-fated candidacy of Larry Summers but in Israel's case things got somewhat messier as Jacob Frenkel (a prior incumbent of this post) was nominated and then forced to withdraw due to a personal issue that had not been disclosed prior to his nomination, and was then followed by Leonardo Leiderman whose candidacy lasted a matter of days. Finally this weekend Karnit Flug has been nominated for a post that it now seems certain she will fill on a permanent basis having served as Deputy Governor under Stanley Fischer and interim governor during the selection process.

This means that Israel's monetary policy can be expected to remain on its particular course, which could be described as "Swiss", in that it seeks to target the currency rate as a primary policy aim in the same manner with which the SNB has kept the CHF/EUR cross rate above 1.20. Rather like Switzerland Israel was fortunate not to feel the full blow of the 2008 collapse domestically, and was similarly only tangentially affected be the Eurocrisis, but its central bank reacted as if it was the epicenter.

The result has been a strong domestic economy in recent years, but one that is becoming mired by growing asset inflation in the form of its property market. Despite the risks caused by this issue the BOI has continued to target a weaker shekel by purchasing significant amounts of FX in recent months, causing money supply to accelerate. September's data showed M1 growing by 3% MoM, the fastest single month since April 2012. Annual growth is now 14.1%, and the 12 month ma of growth has reached 11.5%, the highest level since December 2010.

By allowing money supply to increase at this pace late in an economic cycle the central bank now risks feeding inflationary pressures. We would expect the local equity market to be a "benign" victim, since historically there has been a strong relationship between M1 and the level of the TA-100 index (see chart). Less palatable would be a further leg higher for local property prices, or any outcrop of inflation at the level of consumer prices. Presently CPI remains at a placid 1.30%, but it topped 4% for much of 2011 sparking some significant social unrest.

Thus although Israel's size makes it a fairly trivial participant in the global economy it does have certain characteristics that make it worthy of attention in tracking a potential transition to a phase of higher inflation globally.

It is interesting to note that the release of China's economic statistics for September, together with its Q3 GDP report has generated few top level headlines this morning, suggesting that the agonizing over the state of the world's second largest economy has subsided for the time being. Of course part of the reason for the lack of news is the lack of surprise contained in much of this data, which seemingly never changes much from month to month.

Overall GDP was estimated at 7.8%, in line with expectations and this was also true of Industrial Production at 10.2%. Retail Sales were a little weaker than expectations at 12.3% and Fixed Asset Expenditure also just missed at 20.2%, but this was essentially an "in line" set of data that showed a modest rebound in activity taking place over the summer.

As we have noted before it seems highly likely that the export sector of the economy is growing much slower than the official GDP report, meaning that if today's data is to be believed other portions of the Chinese economy must be outperforming. This would certainly appear to be the case for real estate, where the total area of residential real estate sold increased by 23.9% YoY in September. Although this is the slowest increase since December it is clearly still a rapid pace of change that suggests that mortgage credit remains freely available.

Given the lack of clarity regarding the data perhaps the most useful statistic released last night was the simple Entrepreneur Confidence Index. This survey came in at 119.5, slightly higher than the Q2 reading of 117. Over the 15 year history of this index readings of around 120 have been consistent with a "normal" period of expansion, 130 and above with a boom and anything below 110 a more problematic set of circumstances. This seems about right for the state of China today, with the PBOC still navigating the currents between the risks of an inflationary bubble in real estate and the deflationary outcome of bringing it to an end. None of this in our opinion makes China an attractive destination for investment capital, but it does also suggest that its economy is not an imminent risk for global markets either.

At the time the September "taper faker" FOMC statement was released we noted the surprising inclusion of language regarding a deterioration of financial conditions when none appeared to have occurred in the US. As the minutes of the meeting made clearer when they were released three weeks later, this seemed to be linked to conditions in emerging markets rather than the US, which may be a controversial widening of the FOMC's policy remit but at least absolves them from the charge of ignorance.

Since mid September US Financial Conditions (as measured by the Bloomberg US Financial Conditions index) have continued to improve, with the index actually registering a new all time high of 1.58 on Wednesday (5 years and one day after the index made its record low at -12.67), before falling back slightly to 1.47 this morning. Perhaps more importantly these readings are not the product of a brief blip, since the trailing 10 week ma has now reached an all time high of 1.34, while the 52 week ma is 1.04, the first time this measure has averaged over +1 for an entire year.

In our opinion the length of time that conditions have remained strongly positive is perhaps more important than the level itself, since it generally takes some time for financial conditions to start to filter through to actual economic activity. Perhaps even more striking is the fact that all of this is taking place against a backdrop of domestic monetary policy that is arguably even looser than was in place in the immediate aftermath of the Lehman collapse. We say this since the initial burst of "Credit Easing" had a substantial portion diverted to global markets via the CBLS facility, whereas all of QE3 has been deployed within US Treasury and MBS markets.

As the attached chart makes clear, prior periods of strong financial conditions have typically been matched either by FOMC tightening moves, rather than the emergency conditions kept in place today. Given that we foresee no speedy change to FRB policy we would expect the BFCIUS to move higher from their current level, with the most likely catalysts being a higher SPX index, lower VIX (which remains somewhat elevated at 13.48) and a tighter Baa/10 Year treasury spread.

We do wonder if it is possible that an "upside crisis" +2 reading could actually be registered, which would mean that conditions were 2 standard deviations better than normal. We have hitherto thought that this was an impossibility but we would have said the same about a -12 reading in early 2008 and yet one was recorded exactly 5 years ago.

We have commented several times on the substantial improvement of Current Account data in a number of key Euro-zone economies, and it therefore should come as little surprise that the aggregate data shows a very impressive rate of improvement.

The August aggregate Euro-Area Current Account (SA) reached €17.4 bln, a record for this calendar month, taking the 12 month ma up to €16.1 bln which is also a record. This means that over the last 12 months the total Current Account surplus reached €193 bln, which represents a key source of private sector liquidity both in the form of export earnings and investment capital (the balance has been strongly positive in the Goods, Services and Income sub-categories).

This compares to deficits of €123 bln in the 12 months ending June 2009, and €50.4 bln in the 12 months ending February 2011, swings of €316 bln and €143 bln respectively. In other words the sums involved are large enough to matter even in an economic area as large as the Eurozone. Gains have also been well dispersed with only France showing little sign of improvement over the last three years.

We believe that the improvement in Current Account data has been largely overlooked by market participants, just as the substantial deterioration in emerging market data went unnoticed until currencies dislocated at the end of the second quarter. We would expect rather more attention going forwards as the strong equity market performance of most Eurozone markets starts to generate more interest on the part of investors.

The NAHB Homebuilder Sentiment Survey experienced a modest pullback in October from 57 (revised down from 58) to 55, but remains at a level which is consistent with improving overall activity in the housing market. To put this in perspective the NAHB index was at 41 in October 2012 and remained at this level as recently as April, and the fact that it has remained elevated above 50 during the important summer period despite the fact that interest rates have remained elevated suggests that the recovery in activity has staying power.

The mild deterioration in the headline index was spread across all three sub indexes with each declining by 2 points to 58 for Present Sales, 62 for Future Sales and 44 for Traffic. All of these readings remain comfortably above their level of a year ago and although expectations have dampened a little since the height of summer there is nothing in this data to hint at a substantial reduction in either activity or expectations.

Tokyo Condominium Sales contracts increased substantially in September, with the 4986 reading marking a 113% increase on the level of a year ago. We would caution that in part this surge is caused by a move to beat the upcoming increase in consumption taxes next April but we suspect that a good portion of this improvement marks a genuine willingness to re-enter the housing market after several years of modest activity.

September's report takes the trailing 12 month ma up to 3581 units, compared to 3009 a year ago, making this the strongest 12 months for sales since November 2007. On the other hand we would note that a decade ago sales averaged over 6000 and we assume would have been much higher at the end of the 1980's boom (the data only starts on 2001). Nevertheless we take encouragement from the turn in activity and would expect it to at least partially survive the implementation of increased taxes next year.

Yesterday we commented on surprisingly strong UK inflationary data and made the point that the BOE had moved in line with the FOMC in emphasizing the equal importance of monitoring employment when setting monetary policy.

Although these comments were intended to sooth the local gilt market we see a similar pattern emerging whereby much stronger employment statistics are released at precisely the point at which the central bank has elevated their policy influence. The September unemployment report showed the total Claimant Count falling by -41.7K, the largest monthly fall since 1997, while the August data was revised from -32.6K to -41.6K, making this a very strong report. The 12 month ma shows an average of -18.5K falling off the Claimant Count, the fastest rate of decline since July 1998.

The overall level of unemployment remains elevated at 1351, but it is back to its level in August 2009 and now falling quite sharply. Interestingly there is not much difference between the current level and the readings seen back in 1998, although the employment picture went on to improve considerably over the next decade with the count bottoming below 800K in 2008 (see chart). What we would say is that the speed of improvement is starting to undermine the concept of an "emergency", while yesterday's inflation data showed that there are some risks of an upside breakout in prices in the months ahead. Whether this will be enough to stir either the BOE or the gilt market remains to be seen but a good fundamental argument can now be made in favor of substantially higher local interest rates.

EU Car Sales posted a 5.4% annual increase during the seasonally important month of September (typically the third strongest month in the calendar). The narrower 15 country pre-2004 EU (which makes up the vast majority of activity) also posted a 5.4% gain, with sales reaching 1.10 mm units. This compares with a September 2007 reading of 1.304 mm. The 12 month ma of sales is currently 0.912 mm units, which compares to a pre crisis average of 1.2mm units, indicating that activity remains about 75% of normal at the current time.

As would be expected there is a divergence of activity in the major countries. German sales were roughly flat (-1.2%), but never suffered a deep draw-down in either 2008 or 2011 making this unremarkable. France actually saw sales move up to a record in 2010 thanks to a series of post-Lehman emergency incentives, before a fairly steep decline set in during the 2011 Euro-crisis. It would appear that sales are currently bottoming with September posting a modest 3.4% increase.

The other three markets all suffered much more disruption in recent years. In the case of the UK the bulk of the damage took place 5 years ago and we are now finally seeing the sort of strong rebound in activity that the US has enjoyed in recent quarters, with September (a very important month for UK sales) posting a 12.1% increase (we commented about this strong data earlier this month).

Car sales in both Spain and Italy suffered greatly in 2011, and as a result are still in the process of hammering out a bottom. In Spain's case incentives helped push September sales up 28.5%, but even so at 45.2K they are less than half of their level in September 2007. For Italy sales continued to decline by a modest -2.9% and over the last 12 months have averaged around 55% of their pre-crisis levels. We would expect to see Italy start to post annual sales gains in the coming months, with the deep draw-down in activity allowing for several quarters of growth once the turn is in place.

The ZEW Economic Sentiment survey for October was published this morning which allows us to update our chart comparing the "Current Situation Sentiment" index to the DAX index. Sentiment stabilized close to last month's reading, with the index falling from 30.6 to 29.7. Although technically it was a "miss" when compared to expectations of 31.3 we would characterize this as an "unchanged" report that shows that last month's surge in confidence was rather more than a flash in the pan.

As can be seen on the attached chart this keeps sentiment at a level which is supportive of further gains for the DAX index since we remain well below the sort of readings that would signal a problematic degree of overconfidence. Readers should note that we view this as a useful medium to longer term gauge that has little predictive use over the shorter term, but based on past experience the current bull market in German equities has a fairly long future ahead of it.

One of our central beliefs at the current time is that "unorthodox" monetary policy has overstayed its welcome in a number of key global economies and now risks igniting an inflationary cycle greater than anything experienced for the last 20 years.

Although the bulk of our attention has been directed towards the US economy we have long regarded the UK as a more volatile "cousin" of the US, with economic cycles that tend to be synchronous largely because of the close tie-ins of their financial systems and central banks.

It is therefore interesting to note that inflationary measures in the UK appear to have bottomed at a relatively high level in recent months, at least compared to other major economies, while a host of economic metrics are now suggesting that the housing market and general economy have started to recover their poise ahead of schedule.

September's CPI report showed an increase of 2.7% YoY, ahead of estimates for a 2.6% increase while the alternative RPI report showed a gain of 3.2% (both with and without mortgage payments). This keeps the rate comfortably above the BOE's official CPI target of 2.0%, although below the 3% level which would trigger a written explanation for the overshoot.

We note that in his August statement the Governor of the BOE emphasized the importance of unemployment in setting monetary policy, indicating that the 7% level would be considered an important "way-station" (he was careful to stress this is not a "target" having seen the problems the FRB has encountered in recent months), but this shift in policy focus is predicated on inflation remaining under control. We have rather less confidence that the BOE that this will prove to be the case, particularly if economic activity in the UK accelerates further in the months ahead.

We note that the UK gilt market indicates some unease, with the 10 year yield recently moving just above the current CPI rate, having been in negative "real" territory since the summer of 2010, a highly unusual state of affairs for the UK (much more so than for the US which has had low or negative real yields for most of the last decade). Any hint that CPI is starting to rise to the point that it restrains BOE monetary policy could be expected to force UK yields substantially higher and it will be worth paying attention to this situation in the weeks ahead.

India's PPI and CPI data for September shows that despite running tight very monetary policy over the summer (which to a degree has been loosened in recent weeks) inflation continued to build both in wholesale and retail prices. PPI increased by 6.46% YoY, above August's 6.10% level and expectations of a 6.00% report. This is the fastest level of increase since last February, although it is somewhat better than the September 2012 level of 8.07%. We note that there was a wide disparity in the various sub indexes with Manufacturing prices rising 2.03% YoY, Power 10.08% and Food an alarming 18.4%. Overall the suggests that the improvement in wholesale prices seen since late 2010 has probably run its course.

CPI (a relatively new statistic for India) also came in above expectations at 9.84%, when it was expected to be unchanged from August at 9.5%. This is the highest reading since March and places the data in danger of breaching the psychologically important 10% level. Since this data started in January 2012 the record high is 10.91% (recorded last February) and with the data typically climbing in the winter months there is a reasonable chance that this will be exceeded this time around. This emphasizes the very difficult position the RBI finds itself in, navigating between an industrial sector of the brink of recession, a weak currency and high inflation and we see no easy way out for monetary policy which now risk a period of stagflation.

The PBOC released its credit and monetary data this morning completing a busy weekend for China watchers. This report showed that credit continues to expand rapidly, with the regulated banking sector once more being the dominant source of funding. On the monetary side of the equation M2 continues to grow rapidly while narrow money, both in terms of M0 and M1 appears to be lagging by a substantial degree, again underlining China's shift from a liquidity based financial system to a credit based system.

In terms of the data Aggregate "Social" Financing was exactly 1400 bln CNY, a suspiciously round number made more so by the fact that no breakdown of the data was provided apart from new Bank Loans, which totaled 787 bln. Both these data points were higher than expectations which were 1350 bln CNY and 675 bln CNY respectively. This keeps the 12 month ma of Social Financing at 1497 bln CNY, an annualized pace just under $3 trln per year. Bank loans made up a surprisingly high 56.2% of total financing but since we have no breakdown of other categories we cannot comment on the reason for this. Overall credit growth remains very strong, although it does lag the remarkable levels reached between Q4 2012 and Q1 2013.

The Monetary data showed that M2 continues to grow strongly, increasing 14.70% YoY to a 107.7 trln CNY ($17.7 trln, compared to US M2 of $10.9 trln). M1 on the other hand actually shrank slightly in September by -0.57%, taking the YoY growth back down to 8.90%, while M0, which typically surges in September for seasonal reasons, increased by only 2.87% in the month, taking the YoY growth rate down to 5.70%.

We have commented a number of times on the persistent lag of China's "narrow" money growth rates compared to "broad" money, since we believe that this represents a vital QUALITATIVE shift in the data which is not captured by simply looking at credit data alone. China's financial (and by extension economic) system has undergone a radical shift from one powered by domestic liquidity (which itself largely came from massive export growth) to one which is fueled by new credit issuance. Since the former dominates M1 and the latter M2 tracking the ratio of these measures generates a useful rough proxy of this transformation.

We have therefore attached a chart showing Chinese M1 as a percentage of M2 and for reference we have included the US equivalent. As can be seen although China's M1/M2 ratio is still high compared to the US it has been dropping rapidly in recent quarters. In our experience it is always the CHANGE in conditions rather than the LEVEL which matters, and in China's case this has been substantial enough to suggest some strains may be occurring, or be expected to do so within a matter of months.

From our perspective overall liquidity conditions in China are fairly tight, and although the economic effects of this can be masked for a while by strong credit growth in the end it is liquidity which tends to guide te future, particularly when, as in the case of China today, the profitability of much of the destination of credit is open to question.

China's CPI reading for September rose sharply to 3.1% YoY from August's 2.6% reading, well above consensus estimates for a 2.8% gain. A sharp acceleration in food inflation (which tends to be very volatile in China) was the main driver for the overshoot with this category posting a 6.1% YoY gain.

This would seem to suggest that China's inflationary cycle has bottomed once more, and we note that the trailing 12 month ma has itself started to turn upwards, increasing to 2.4%. Although the current level of inflation is not itself problematic China inflationary tendency remains quite embedded in its economy with two separate surges above 5% taking place since 2008 (see chart). Any further increase in CPI from the current level will start to put pressure on Chinese authorities to consider tougher monetary measures despite clear evidence that the non-housing related portions of the economy are already under some duress.

China's trade data continues to suggest that the once almighty export sector is no longer the primary engine of growth for the overall economy. This is particularly apparent when one strips out exports to Hong Kong which became tainted by false certificate filings towards the end of 2012 to a degree that distorted the overall data.

September's report showed overall exports of $185.60 bln, a decline of -0.3% from a year ago, compared to an expected growth rate of 5.5%. We would not make much of any single month's data but in the five months since since April (when the Hong Kong mis-filings were finally clamped down upon) the YoY growth has ranged between +7.2% and -3.1% and averaged 1.78%. We would therefore estimate that export growth is somewhere between 0% and 4% and that there has been no substantial increase in activity since export growth started to shrink last year.

Given the issues with the Hong Kong data it makes sense to eliminate this portion of exports as a cross check of activity. As can be seen on the attached chart this shows that export activity has flat-lined over the last 6 months. September posted a small annual decline of -0.8% while the 12 month ma is at $149 bln, only $3 bln above its level in January.

Import data has grown by an average of 4.8% YoY since April, and although this is below China's purported GDP growth for this period we would claim this to be alarmingly so. What we would say is that there is no support from trade data on either side of the ledger for the commonly held notion that the Chinese economy started to re-accelerate earlier this year.

The explosive growth of Japan's monetary base continues to have a modest but persistent effect on monetary statistics suggesting there has been some transmission of central bank assets into the broader financial system.

September's monetary aggregates were published last night and showed M2 to be growing by 3.8% YoY, having reached a record ¥850.8 trln. This took the trailing 12 month ma of this measure up to 3.1%, making this the most persistent 12 month period for monetary growth since January 2003. As would be expected there is a good historical fit between expanding M2 and local economic activity, making this an important metric to follow when judging the effect of the BoJ's current radical policy stance. As a general rule while an increase in the monetary base can aid financial stability (which in Japan's case was not a major issue either a year ago or today) it is the growth of broader monetary aggregates that denote a more useful deployment of this liquidity into the broader economy.

It remains to be seen if M2 can continue to push higher from here with 4% marking something of a milestone and 5% (recorded in February 1998) marking the fastest annual growth seen since the end of the great economic boom, but the positive slope of the 12 month ma denotes a degree of positive acceleration that is unsurprising given the massive growth of monetary base in recent months.

Eastern Europe has been a notable (and welcome) source of stability for the emerging market complex in recent months and in part this can be attributed to an improving trade position for a number of these countries.

Poland published its August trade report this morning, which showed a surplus of €264 mln. Although this figure is small it does represent the first time that Poland has registered a positive trade balance in August since this data series and compares to an August deficit of €1.150 bln as recently as 2010. The trailing 12 month ma of the trade balance is €40 mln, a record (if modest) high and only the second time this metric has been in positive territory.

Encouragingly it is an improvement in exports which has driven this trend, with August seeing a total of €12.45 bln of goods exported, a record for this calendar month. The trailing 12 month ma also registered a record of €12.71 bln, underlying the clearly improving trend of Poland's trade position.

Turkey shares with India the problem of a yawning current account deficit and a subsequently weak currency although it has taken less draconian steps to date to address either issue. Nevertheless this morning's unemployment report for July does suggest that the economy has started to slow appreciably with the Unemployment Rate spiking up from 8.8% to 9.3%, well above expectations of 9.0%. Even allowing for normal seasonal fluctuations this is a large monthly rise from June and a large annual rise from last July's reading of 8.4% and it is confirmed by the change in direction by the trailing 12 month ma, which has now risen to to 9.49%, its highest level since March 2012.

As for the Current Account, this was measured at -$2 bln, close to expectations of -$2.1 bln. It should be noted that August is typically a strong month for capital inflows, aided by Turkey's massive tourist industry, although this month's report was somewhat marred by the size of the "Errors and omissions" input, which came in at +$2.9 bln. This line item includes an estimation of non-reported transactions, which by definition is a somewhat untrustworthy statistic.

Even with the help of this input the August report was a little worse that August 2012's -$1.26 bln, and so caused the trailing 12 month ma to move down to -$4.72 bln, the lowest reading since August 2012. Taken together these reports show Turkey's economy to be under rather more pressure than most observers (or at least economists) understood to be the case and we would expect the local equity market, bonds and currency to fully participate in any further bout of weakness in emerging markets.

Earlier this week we outlined the success of India's recent monetary tightening in narrowing the current account deficit (we note that the recent breakdown of gold through key support does suggest that Indian demand for the metal has been substantially curtailed) but it is equally unsurprising that these policies are exacting a considerable dampening effect on local economic activity.

August's Industrial Production report certainly suggests this to be the case with the annual growth slowing to 0.6%, well below expectations of 2.0% (although we note July's report was nudged higher to 2.8% from 2.6%). This kept the trailing 12 month ma steady at 1.1%, meaning that any future slowing would pull this metric into negative territory.

Interestingly the production of Consumer Durables is starting to stick out as a source of weakness, falling -7.6% YoY in August and by -4.6% YoY on a trailing 12 month basis. The latter covers a long enough period to smooth out the volatility of this measure and suggests that at least this portion of the Indian economy has slipped into a recessionary status.

With the summer vacation season over Japan saw a steady build up of both bank deposits and outstanding loans in September. Deposits rose by ¥1.6 trln (0.28%) to ¥591.4 trln and have increased by 3.8% YoY. The recent pace of deposits build up is the fastest seen since 1999 and suggests that the massive increase in monetary base is having an effect on domestic savings.

Credit expansion remains steady, growing by ¥1 trln (0.25%) in September and increasing by 2.3% YoY (excluding trusts). This takes outstanding credit up to ¥406.6 trln, its highest level since April 2009. It should be noted that back then deposits were ¥529 trln, generating a deposit/loan ratio of 1.3, compared to a reading of 1.45 today.

Just because a change in monetary policy has been fully anticipated this does not mean that it will be without effect (readers may recall the utterly predictable FRB hikes of 2004-6), and so the hike in Brazil's SELIC marks another tightening in a domestic economy that is already teetering on the brink of recession.

Since the last rate rise took place at the end of August both the currency and local equity market have recovered somewhat, with the former being helped by a massive intervention in currency markets. On the other hand both remain under pressure and we note that in recent sessions the IBOV index has been threatening important support around the 52,000 level.

As for the BRL after dropping like a stone to 2.455 on August 21st it has recovered to stabilize around the 2.20 level. Although this may seem like progress it hardly represents a stable equilibrium and any sense that tighter monetary policy is having a negative effect on local economic activity would be likely to lead to another withdrawal of investment capital.

The minutes for the September FOMC meeting confirm our sense that a long and tortuous discussion took place over the exact timing of a reduction of asset purchases. This discussion displays one of the key problems in letting data rather than subjective judgment guide policy, namely that by the time data is consistently and unambiguously positive (or negative) the underlying policy will have long outstayed its welcome.

It also highlighted a central misconception which has taken hold in recent months both at the level of the FOMC and amongst market participants. The general belief is that FOMC policy controls the bond market, whereas we would argue that the bond market now controls FOMC policy.

India's trade report for September showed a surprising degree of improvement with imports falling -18% YoY to $21.24 bln and exports growing 11.2% to reach 12.20 bln. This generated a trade deficit of -$6,760, the smallest since March 2011.

The primary reason for the decline in imports is the severe constriction on gold and silver imports with both taxes and re-export requirements (at least 20% of gold imported must now be re-exported as jewelry) serving to decrease September's bullion imports to $800 mln compared to $4.6 bln a year ago. With a decline of this magnitude one must ask the question as to whether a portion of prior imports have now gone underground and are simply not being captured by official statistics. If in fact smuggling has been minimal this would represent a very significant decline for global gold demand. A drop in crude imports accounts for another $1 bln or so, meaning that other imports actually rose on a YoY basis.

On the export side an increase of 11% is clearly a welcome change in direction, and may be the first sign that Indian exporters are benefiting from the sharply lower level of the INR. As with all trade data we would avoid reading too much into any single month's report but the scale of September's improvement does suggest that some progress is being made.

One of the more encouraging trends in Europe in recent months has been the substantial improvement in the trade position of a number of southern European countries. It is interesting to note that the same cannot be said of France, which continues to run a wide trade deficit, which has only modestly improved since the days of the Eurocrisis.

The August Trade Balance was reported at -€4.91 bln this morning, just beating expectations of -€5 bln. This is an improvement on last August's -€5.9 bln level and is the best August report since 2009. However, as the attached chart shows the recent improvement in the deficit has not yet allowed the trailing 12 month ma (currently -€5.07 bln to recover to its 2008 level at -€4.8 bln).

Although we would not describe the current situation as dangerous, or approaching the problematic trade positions of countries such as India or Turkey, it does represent something of a missed opportunity for France. Although to an extent the surge in exports out of Spain and Italy have been born out of necessity (France's domestic demand for goods and services has been much more stable), it is also true to say that they have been born out of opportunity.

In the case of France exports have increased at a more modest pace, indeed during July Italian exports exceeded French exports by the most since July 2007 and the second most in history (see chart) and although one has to allow for the fact that Italian industry almost entirely shuts down in August, which means that July's data is always very strong, the recovery of Italian export activity has been more robust in recent quarters.

This ties in with our viewpoint that France represents the least attractive large European country for investors at the current time, although we would allow for some individual companies to buck this overall trend.

With the government shutdown extending into a second week, and both the "D" and "L" words being bandied about we are starting to see clear evidence of protection being added to portfolios.

Yesterday saw a surge in the VIX index, which gained 2.67 points (15.95%) to close at 19.41, its highest close since June 24th, the date the SPX bottomed at 1560.3 (and closed at 1573.09). Although recent market action has been poor, it does not yet compare to the correction that took place in May and June, and this can be seen in the change to the 20 day historic volatility of the SPX which remains quite muted at 9.62, almost half its level in late June.

Of course as its name suggests historic volatility is backwards looking while the VIX is sensitive to the market's perception of a future move. Nevertheless we are starting to see something of an "event premium" being built into option prices, much as took place last December at the time of the obsession with the "Fiscal Cliff".

Should no problematic event take place it would be reasonable to expect something of a "fear unwind", which would have generally positive implications for the equity market. This certainly was the pattern in early January when the messy debate in Washington served to keep money on the sidelines even as corporate and economic data pointed to an improving environment for US equities.

We have not yet registered as clean a signal as the December 28th spike in the VIX to 22.72 (see chart), and it could be argued that the rift between (and within) the parties is more pronounced this time around but our suspicion remains that direction of the market's next significant move is more likely to be determined by the quality of the upcoming earnings season than the quality of political leadership in this country.

The lack of official US economic statistics coming out of Washington would seem to have freed up acres of newsprint and screen-space for commentary on the shut-down and what it means for global markets. We never thought we would miss the monthly ritual of the non-farm payroll release but frankly we realize we may have been too hard on the economic community given what their political brethren had to offer.

There are of course no shortage of spokesmen willing to comment on a situation that is both unusual and loaded with political significance. In particular we would be wary of paying too much heed to any individual clearly associated with one side of the argument or the other since political standing has a habit of scrambling the normally lucid thoughts of many a market commentator and financial guru.

In our opinion the best guide to all of this are markets themselves. Regarding equities we see nothing strange in the SPX and other major indexes stalling near to their record highs, and would allow for some selling pressure that should not build to the point at which important support is troubled. We would also remind readers that by tomorrow evening earnings season will be upon us, providing a useful "bottom up" focus for the equity market.

We note the treasury market has been well behaved (even in the face of strong economic data) and while some would attribute this to the traditional flight to a safe haven this really should not apply in the case of a potential crisis caused by a failure to pay interest on these instruments.

Perhaps most importantly of all global financial conditions show no hint of a US led crisis being unleashed in the coming sessions. US financial conditions remain extremely positive, with the BFCIUS index (red) at 1.28 this morning. Although this is a little lower than it was in August (when it reached a 19 year high) there is no hint of the sort of deterioration that took place in the build-up to the collapse of Lehman (the index was already at -2.9 on the Friday before the collapse) or even the buildup to the Eurocrisis in 2011. Although it is always possible that the market "has it all wrong" we doubt that this will prove to be the case, although we will continue to monitor the index just in case a dramatic negative shift in readings takes place.

European conditions remain modestly positive at 0.28, just above their average since last October and again there is no sign that European financial markets have been rattled by the events (or lack thereof) in Washington. If anything the standoff has acted to mask the underlying strength of a number of European equity markets, with Italy's FTSEMIB pushing up to a new 2 year high and threatening to finally leave the 18,000 level behind it.

Meanwhile financial conditions in the emerging market complex remain negative, although above the -2 level which would indicate the onset of crisis. The BFCIAXJ index (which follows Asian markets ex-Japan) is at -1.37. Here there has been some deterioration, with the index falling back from its September high at 1.146, although the index remains above its late August low at -1.625. This is a useful reminder that despite the focus on Washington, financial markets continue to indicate that EM is the most likely area to generate problems going forwards.

Unsurprising employment confidence has a marked relationship with consumer activity, particularly with regards to large ticket items. It is therefore no surprise to see that the sharp improvement in UK employment confidence (See earlier note) coincided with a very good month for Automobile sales. Given that September is an extremely strong month seasonally (marking one of the two months in which number plate registrations are changed, which helps protect resale value much in the way that annual registrations do in the US) the strong data will have a meaningful impact on the entire year's new car registrations.

Total Registrations were 403.14K, the strongest single month since March 2008 (March is the other month in which registrations are changed) and an increase of 12.1% from September 2012. This takes the trailing 12 month ma of sales up to 184.9, its highest level since September 2008. Pre-crisis sales averaged around 200K a month, indicating that the UK car market is still operating at around 90% of its normal level. Over the last 5 years sales have averaged 169K, meaning that the total "lost sales" over this period is around 1800K, or approximately 9 months of average pre-crisis sales (in the US the equivalent figure is close to 12 months). This should allow sales to get back to normal levels in the coming months and perhaps stay a little higher as consumer's replace ageing vehicles that would in more normal times have been sold a while ago.

The Lloyds Bank Consumer Employment Confidence survey measures responses to the following question:

DO YOU THINK EMPLOYMENT PROSPECTS IN THE UK IN GENERAL ARE BETTER OR WORSE THEN 12 MONTHS AGO?

Interestingly this metric has never registered a positive reading (indicating a majority of respondents believing prospects have improved) since it was introduced in late 2004 despite the fact that the UK was in the middle of a strong period of economic expansion (a reminder that each consumer confidence metric needs to be judged against its own history). However, the metric has shown enough cyclicality to be a useful measure of confidence and the very sharp improvement in recent readings can therefore be taken as evidence that a considerable improvement in consumer confidence related to employment has taken place this summer.

September's reading was -13, 9 points higher than August's 22 reading and 36 points higher than the -49 level seen a year ago. Indeed this is the best single month reading since July 2005 when confidence was helped by a strong economy and even the awarding of the 2012 Olympics to London that month. Whether or not the index can continue to improve and register its first ever positive reading (it reached -1 in February 2005) remains to be seen but the improvement in UK employment confidence indicates that enough improvement has taken place in underlying conditions to have started to meaningfully change the attitude of consumers.

The ISM Non-Manufacturing report for September came in at 54.4, missing consensus of 57 but still providing plenty of data below the headline print to suggest that the service sector continues to experience growing demand. New Orders came in at 59.6, down slightly from last month's 60.5 but still a very strong result, but current Business Activity moderated down from 62.2 to 55.1. Given that orders lead activity we would not be concerned by this slippage, particularly since the Inventory build moderated to 54.5 from 56 last month.

Interestingly New Export Orders rose to 57.5 from 50.5, the strongest data since February while Imports weakened to 51.5 from 55 (both sets of data tend to be quite volatile) while Employment moderated to 52.7 from last month's strong 57 reading.

In summary this is a decent set of data which shows the service sector remains in a prolonged period of expansion although the "headline miss" will likely draw the attention of a market which seems for the time-being to be looking for reasons to be miserable.

We have always been firm believers in the superiority of the weekly Initial Claims report over the monthly BLS Non-Farm Payroll report as a (reasonably) accurate guide to an employment cycle. We are therefore fascinated by the very strong data which has been released in recent weeks and the fact that this was extended by this morning's estimation of 308K Claims, below (bullish) consensus of 315K.

This takes the trailing 4 week ma down to 305K, the lowest reading since May 2007. However, this does not tell the whole story since back in 2007 the data was bouncing along the bottom while at present Claims are collapsing at a rapid rate. This brings up the real possibility that Claims will fall and remain below the key 300K level in the coming weeks, something which generally only happens during periods of very rapid economic expansion.

The attached chart shows the 4 week ma of Claims reduced by 300K each week, meaning that for periods in which Claims are less than 300K the histogram turns negate (and red). As can be seen over the last 30 years the only periods in which Claims were less than 300K were October 1987 (briefly), October 1988 to February 1989, June 1999 to September 2000 and February to May 2006.

At the very least this means that for those currently employed in the US (the vast majority of consumers) the likelihood of losing their jobs is extremely remote, with clear implications for confidence and the willingness to purchase (and borrow if need be) large ticket items.

It also brings up the question of credibility for the Non-Farm Payroll report which has remained largely static over the last 12 months, averaging around 180K a month for this period. In order to reconcile this data you would either have to believe that Initial Claims are entirely erroneous (unlikely given that they are derived from actual claims made in state offices) or that employers hired around 100K LESS employees a month in the 12 months ending in September 2013 than the year ending September 2012. Although we are prepared to believe there has been no significant acceleration of hiring, we do not believe that there has been significant less willingness to take on labor.

We must therefore be open to the possibility that the Non-Farm Payroll report and the Household Survey which drives the Unemployment Rate are significantly underestimating the strength of employment gains in recent months. Given their wide error tolerances and publicly admitted deficiencies at tracking employment at smaller and new businesses this would come as no surprise, but it does have obvious implications for the setting of monetary policy and the undertaking of economic analysis.

We remained convinced that the US economy is moving on a substantially faster track than is widely realized, and concerned that monetary policy is currently calibrated for the economic and financial conditions that were in place 5 years ago. Eventually at some point in a cycle economic reality and monetary policy (and sometimes even economic analysis) converge and given the current gap we would expect this to be a fairly explosive process whenever it finally occurs.

Ireland's unemployment cycle peaked last summer and since July 2012 there have been 15 consecutive monthly drops in the Live Register of Unemployed Persons. September saw a fall of -1.8K, which takes the decline over the last 12 months to -20.8K, the largest annual drop since April 2001. As we commented earlier in our note on Spain this turn in unemployment is a much more powerful force for local economic activity than is generally recognized and the change in local confidence since last summer, both at an individual and corporate level in tangible in Ireland.

Of course much still needs to be done and the Unemployment Rate remains unacceptably high at 13.3%, although it has declined from 14.5% a year ago, and is now back to where it was in June 2010. We continue to expect good progress to be made in the months ahead with the current pace of improvement looking to be sustainable for the foreseeable future.

The likely suspension of the non-farm payroll report release this Friday means that the ADP payroll report will probably have the headlines for itself, which is unfortunate given that this has been a fairly inconsistent set of data since the decision to introduce a new methodology in October 2012.

September's report showed total gains of 166K, a little less than expectations of 180K while the August report was revised down from 176K to 159K. The trailing 12 month ma rose slightly to 175.3K, its highest level since August 2012. In other words this report is essentially in-line with expectations once one allows for the error tolerance of the data. We would not conclude anything from this data other than to note that it clashes with the increasingly powerful evidence from the weekly Initial Claims report that the US employment cycle has markedly improved in recent months, a subject we will comment on tomorrow.

The Spanish unemployment cycle would appear to have finally peaked this summer a key turning point for economic activity since from this point on the odds of those currently employed keeping their jobs should be better than even. This concept is largely lost in conventional economic analysis which focuses on the level of unemployment (which is always dauntingly high at its peak) rather than considering the fact that once it has peaked re-employment becomes an additive force for economic activity. Moreover, for those currently employed a steady rise in confidence that they will remain employed should now become apparent, which in turn should start to show up in an increased willingness to consume at a normal rate. This certainly has been the pattern in the US since late 2009 and in the UK and Ireland (whose September data we will comment on later) in more recent quarters.

Spain's September data showed an increase in unemployment of 25.6K, but since this data is not seasonally adjusted and September marks the wind-down of the peak tourist season this is a fairly strong report that comfortably beat expectations of 35K and last year's reading of 79.6K. This takes the trailing 12 month ma down to 1.59K, meaning that a total of only 19.07K was added to Spain's unemployed over the last 12 months, the smallest increase since July 2007.

Interestingly Male Unemployment has improved somewhat more than its Female counterpart, with the total unemployed FALLING by -36K over the last 12 months, the first time since May 2007 this category of unemployment has dropped on a year over year basis, and a very important development according to our way of thinking.

Travel commitments meant that we were unable to comment on yesterday's ISM Manufacturing survey in real time but we do want to stress that this is another excellent set of data that supports our notion that the US economy has enjoyed a substantial re-acceleration in recent months.

The overall PMI index rose to 56.2, beating expectations of 55 and last month's strong reading of 55.7. Again we would stress that readings in the mid-50's coming 4 years into a period of expansion really are quite significant, as is the fact that clear signs of strength were seen in the New Order (red) sub-index which came in at 60.5. Although this is slightly less than August's torrid 63.5 reading it still represents a significant improvement in New Order's on a month-over-month basis. Given this it is unsurprising that Production (blue) remained strong at 62.6 (62.5 last month) and it is encouraging that this finally seems to be affecting the Employment index (pink) which rose to 55.4, its highest reading since June 2012.

It would appear that the focus of the government shutdown ameliorated its impact on the bond market, but we cannot stress clearly enough that much of the US economic data that has been released in recent weeks is utterly incompatible with the current level of yields offered in the bond market. Sooner or later something will have to give and we doubt that it will be the data which collapses.

The end of the 3rd quarter allows us to update our study of rolling 5 year and YTD returns for a variety of asset classes. Looking at the 5 year returns first we see that the NDX index is now the clear winner, with a total return of over 100% since the end of Q3 2008, despite the fact that this period includes the post-Lehman meltdown. In second place comes the CS HY index (grey) returning 85.7%, although it should be noted that these returns mostly took place between 2009-12. Perhaps surprisingly the SPX index (black) now comes third at 61.2%, just beating out EM USD credit (purple) at 60.6%. EM local currency credit (pink) ties with EM equity (green) at 42.8% and 41.7% respectively, while medium term treasuries (light blue) return a surprisingly disappointing 32.5% (just over half of the SPX's 5 year return). The big loser is the CRB Total Return (orange) which dropped -17.3% over this period, a reflection of how inflated this index became in the summer of 2008.

Of course these returns need to be considered in conjunction with YTD performance in which it is a simple story of US equities vs. Everything else (note that the same would be true of virtually all developed equity markets). The SPX and NDX have both returned approximately 20% so far this year and it is a long way down from here to the CS HY index at 3.6%. All of the other asset classes are in negative territory ranging from the CRB index -3.7% to EM USD bonds -7%. Although the nominal losses are modest the relative performance gap of 25% or more can only be described as punishing.

Interestingly the end of Q3 saw no obvious reallocation away from YTD losing sectors and into US equities, in marked contrast to the end of Q2. This suggests that investors remain patient with their losing trades and that the potential for another wave of reallocation later in 2013 remains present.

The most likely catalyst for this would be another batch of stronger than expected economic and corporate data. Of course the government shutdown will to some extent limit data releases for the time-being, but there should be enough private sector metrics (starting with ISM later today) to give some sense of how September is shaping up.

Please note that due to travel commitments our analysis of the ISM report will be delayed until tomorrow morning.