Has the Chinese panda returned?

In the middle of the year the dragon of the east hit a strong (panda) bear market as the repo rates spiked, fraudulent invoicing was clamped down on and speculative lending was partially wrung out by the central government. 

The moves in Chinese markets on Friday suggest the panda is back; there are 17 different indices in China. The big three CSI300, Shanghai Composite and the A50 (futures market) have just experienced the worst trading week since 1994. The Shanghai composite registered its ninth consecutive day in the red on Friday as repo rate market imploded.

The cash crunch in China will be the biggest news story to start the New Year. The seven day rate added 100 basis points to 7.6%; a six month high to be back at the same level seen when the panda market was in full flight. To highlight how strong the liquidity crunch is rate range fluctuation were so violent the rate moved from 3.8% to 10% over the day.

From what we gather from the communication out of China, however, is the December spike appears linked to the end-year flow of fiscal funds due to normal public policy. I don’t believe this is a major medium term issue as the repo market rate at the long end hasn’t really moved. In December the government typically draws down its deposits from the central bank to disperse the funds to state-run entities with accounts at commercial banks.

The PBoC at the other end of the market drains liquidity to offset the surge commercial banking liquidity. In similar fashion, the PBC has suspended scheduled liquidity injection operations over the last couple of weeks until the weekend when it put CNY300 billion (US$49 billion) into the repo market yesterday to try to stabilise it.

I believe this is a short term issue and the fact that longer term rates have not changed suggest the issue is going to be short dated. 

However the current changes by the PBoC and the central government for a more freely floating interbank lending rate, has seen the market slightly resisting the change. The fact the PBoC has slowed its reverse repo purchase (until the) has also causing slight jitters as the they look to see if the market can stand on its own two feet.

The changes coming from the Third Plenum are the first step towards a freer Shibor rate; a freely floating interbank lending is a much needed step toward a liberal market rather than the current heavily pegged market currently operating.

Therefore I think you are going to see the Chinese panda nesting for another few weeks as the government draws down on its fiscal store and the policy change filter through and that is likely to affect the China facing cyclical plays as manufacturing and infrastructure providers slow down as lending slows.

We will be watching the repo rates again today to see if the PBoC intervention slows the cash crunch. This may cause the equity bounce from last week to come under some slight pressure.

Ahead of the Australian open

Trade in the ASX will also be affected by seasonality at this time of year with only one and a half trading days before Christmas and only Friday, Monday and a half day on Tuesday next week to come in 2013 it’s unlikely we will see any major fireworks.

What might happen, however, is window dressing; hedge funds and fund managers are likely to start closing positions for the end of the month, end of the quarter and end of the year. It’s likely that specific pockets of the market will experience irregular trading activity and volumes as the managers fixed up their books in preparation. Be prepared for positive and negative moves on little to no news.

We are currently calling the ASX down two points to 5263, however as I mentioned earlier, volumes may be light as investors have already set off for Christmas holidays and this could easily reverse. Iron ore held steady over the weekend despite the repo rate cash crunch at US$132.70 a tonne, and may see some positive reading in the material space however again the fact China is under pressure is likely to see China-facing cyclical plays coming under review.

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