Markets sank today as news out of China perhaps reignited the spark of concern about the state of the banking system. Not only did the largest banks triple the amount of bad debt write downs, but the SHIBOR rate also spiked over the day by the largest amount since June.
As the chart on the left shows, the rise today is almost imperceptible compared to what we saw mid-year. So the prospect of more bad loans isn't causing the same kind of stress that the rumours surrounding China Everbright did back then.
Perhaps this has gathered more notice than it otherwise would, given the vacuum of news for markets left by the resolution to the deadlock in the US Congress and the prospect of tapering by the Fed currently being pushed back.
But the reaction to this news is informative of where the risks are concentrated if the news from China did turn more negative. As I
posted here, this is the looming risk to the current status quo.
On of the more interesting reactions was from the Australian dollar. Earlier in the day, the key Q3 CPI data surprised to the upside. While any action on policy rates by the RBA in the immediate term was pretty low, this data means that it is essentially zero barring some kind of catastrophic event.
This initially sent the AUD higher, which has rocketed in the past few weeks. But these gains were unwound on the emerging stories on Chinese debt write-downs and the SHIBOR hike.
So along with some commodities like copper in particular, perhaps it is the AUD that has the most to loose from a change in tack in China, by virtue of it being so strong of late. To be sure, not only is the China risk a big headwind to the AUD, but also changes elsewhere globally and domestically.
For example, US Treasuries have rallied a lot since the last Fed meeting which caught markets off guard. While the taper looks to have been put away for sometime, it will perhaps come into play sometime in late Q1 given leading indicators suggests things should improve.
On the domestic front, the recent data has been a bit better, but not enough to think the end of the rate cutting cycle is over. While house prices in some states have shot higher, the reaction since the RBA started cutting rates is still relatively muted. More importantly, there still appears to be considerable downside risk to forecasts not withstanding the small improvement in confidence.
The big widening in bond spreads in the last month or so at the shorter end of the curve has largely been driven by a sell off in Aussie bonds. But this is not something it that will be persistent if China is more inclined to slow than strengthen.
