A Quick Look Inside China’s Tightrope Walk

If you struggle mightily when it comes to understanding exactly what the fuck is going on in China’s financial system, you’ll be forgiven because after all, it looks like this:


But this is one struggle that’s probably worth the effort because as we and so many other folks have endeavored to explain, the entire global credit impulse depends on it. Simply put, without the batshit crazy system mapped in that flowchart, there is no net private sector credit creation globally.

This week we got the latest TSF data out of China and as we pointed out first thing Friday morning (and as some other folks caught up with roughly 8 hours later), the numbers showed that while credit to the real economy held up, the shadow banking complex was squeezed.

As hard as it is to believe, the number in the red box in the table shown below matters a lot:


That’s leverage being sucked out of the system by Beijing’s tightening efforts and you’ve gotta think that given the shadow banking complex’s role in fueling speculation, it’s no coincidence that entrusted loans fell in the same month that we started seeing evidence of what amounted to margin calls across the system.

For instance, this week the 5s10s curve inverted. WSJ ran a piece on that and posited the following explanation for the anomaly:

The answer seems to lie in Beijing’s recent campaign to tamp down the burgeoning shadow-banking sector, whose growth is due in large part to so-called wealth-management products.


But in pursuit of these outsize returns, they often make highly leveraged bets on assets from bonds to stocks to commodities, and that has alarmed authorities. In recent weeks China’s central bank has raised the cost of short-term borrowing while the banking regulator has warned against market “irregularities” such as the explosion of these highly leveraged products.

The crackdown has prompted many issuers to sell bonds in their portfolios to repay investors. While the selling has been broad-based, investors have been ditching five-year government bonds, where the market is less liquid, faster than 10-year bonds, where the market is more actively traded but also cushioned by demand from long-term investors.

Meanwhile, chaos is showing up in all kinds of other places from commodities to stocks (well documented here and elsewhere – all you have to do is Google it).

Given all of that, you might also want to note something that didn’t get a lot of coverage in the US but is nonetheless worth mentioning.

On Thursday, 10Y yields in China dropped after running up to two-year highs on news the PBoC was planning to conduct an MLF op on Friday.

The PBoC injected funds via OMOs on Thursday after a long hiatus and Beijing refrained from offering MLF loans last week, when CNY230 billion of the contracts matured.

On May 3, the benchmark repo rate jumped by the most in a month on jitters surrounding the lack of MLF rollover. Specifically, the 7-day repo rate rose by 19bps, the most since March 31, to 3.18% while the O/N tenor rises 6 basis points to 2.92%, the highest since April 2015.

“People are getting very nervous, as it seems like the PBOC didn’t roll over the MLF today,” Qin Han, an analyst at Guotai Junan Securities said at the time, adding that “market liquidity is fragile and the sentiment is not good.”

Essentially, people were freaking the fuck out, so China had to step in this week with a new MLF op. “The People’s Bank of China is aiming to stabilize market expectations with MLF operations reported by some media and not to ease monetary policy,” China Securities Journal said on Friday, citing “unidentified analysts.”

Ultimately, the speculation turned out to be correct:


The breakdown was 66.5b yuan of six-month MLF and 392.5b yuan of one-year MLF, with interest rate unchanged.

Again, this is important because it shows how fragile sentiment is and it’s also a textbook case of the PBoC trying to curb speculation while maintaining ample liquidity. Note how they were careful to control the messaging by saying the MLF op was “not an effort to ease monetary policy.”

Here’s a snapshot of the trend here along with a breakdown by instrument:


As dry as all this seems, do yourself a favor and keep tabs on it.

Otherwise, you’ll wake up one morning and not understand why everything seemed to fall apart while you were asleep.

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