Focus switches to Chinese credit squeeze

While markets have been almost singularly focussed on Fed policy in recent weeks, something more interesting in brewing in China.  Interbank lending markets look to have been effectively closed, with SHIBOR (Shanghai Interbank Lending Rates) skyrocketing to extremely high levels.

The catalyst for this move appears to be reports that China Everbright failed to make repayments on short term money due to tight liquidity, which initially locked up markets.  The move was then amplified by the People's Bank of China surprising many by not providing additional liquidity into short term interbank markets to unlock the flow of credit.

Rumours are that the PBC are now providing targeted funding, but the actions of the PBC speak volumes of the change in policy direction from Chinese officials.  It is not slower growth and low inflation that are the key trade off, but the explosion of credit that has policy makers most concerned.

Chinese monetary policy is not as straight forward as in other countries, as officials have more control over certain aspects of credit flow. Traditionally, policymakers have been able to affect almost all parts of credit availability by enforcing credit quotas and interest rates at state-run financial institutions.  There was some constraints though, particularly in managing capital inflows required to keep the exchange rate on a desired path.

But more recently policy makers have been loosing their grip over the control of credit due to the rise of other sources of funding.  Lending from investment trusts has been very strong, while the use of undiscounted bankers acceptances (short term lending that can be moved off banks balance sheets) has also exploded in the year to date.

Squeezing interbank markets is aimed at pushing at speculative lenders out of the market. In particular, bankers acceptances should be affected by the drying up of short term credit, while trust lending is also reportedly a target.

This may cause a high level of concern amongst investors given spiking interbank rates were a feature of the financial crisis in 2008.  I think a key difference is that the PBC to some degree is more deliberately starving interbank markets of funding as it wants to drive out bad lending.  In 2008, policymakers were always fighting a loosing battle to keep markets propped up as the magnitude of the problem was different.

As a reminder of the risks to growth, the Chinese flash PMI was weak, at 48.3.  Its hard to gauge what this means, given its about where it was this time last year and things weren't disastrous then.
But it does appear that Chinese activity is slowing, which along with this credit squeeze is likely to send commodities and commodity currencies lower.