As China tightens credit (after an unprecedented credit expansion in response to the financial crisis), one of its biggest banks, the Bank of China, has halted new yuan-denominated loan originations, on concerns of unsustainably fast lending growth.
This announcement is shaking equities and other risk assets and the only thing that seems to be benefitting is the USD.
With meager bank results coming out, especially in regards to top-line and growing loan loss provisioning, and now an aggressive move from China in reigning in liquidity, deleveraging and deflation will reclaim their hold over financial market fluctuations.
The QE liquidity here at home still has a few hundred billion in Agency MBS purchases to fuel another 10% or so in equity market gains, but with one of the most bubbly economies (China) facing credit tightening and liquidity close to drying up here at home as well, the dollar should be beginning a sharp reversal and risk assets a sharp selloff.
The credit tightening in China should particularly affect the commodities China has been buying and storing for GDP “padding,” particularly copper.
Though active credit tightening in the summer of 2008 catalyzed the fall 2008 mean reversion of the credit bubble, the deteriorating credit backdrop of the current macro landscape is sufficient for the next wave of the credit crisis to manifest. Statements from central banks affirming the status quo by curbing future liquidity (even without actively withdrawing the liquidity already injected) should be enough to get the chain reaction started.
The leading CSI 300 Index, a weighted equity index that replicates the Shanghai market, has been lagging the S&P 500 since August. The CSI 300 began crashing well before the S&P did and it also led on the bounce back, beginning its rally in November 2008, a full four months before American markets bottomed. It looks ready to break down again, having topped out in August of last year, suggesting American markets top out December-January, which has important implications. China and commodities should be the leading assets on the way down, with American issues lagging. The relative underperformance of the leading CSI 300 against the S&P 500 is shown below.