China triggers fear

The credit markets experienced their worst day of the year so far after Chinese PMI data raised concerns about a potential hard landing for the world's second-biggest economy.

The Markit Flash China Manufacturing PMI fell to 49.6 in January from 50.5 in December, a six-month low and below expectations. A reading lower than 50 indicates contraction and can have a psychological effect on the market.

China's CDS spreads are now trading at 97bps, some 30bps wider than levels seen two months ago and the widest level since September 2013. The PMI reading was hardly a disaster, so it may be surprising that the market reacted negatively. But there also underlying fears about China's shadow banking sector, particularly the possibility of a default in one of many wealth management products (WMP). These are widely used as funding vehicles for local government investment projects, many of which are suspected of being white elephants. The sheer scale of shadow bank lending and the capacity of the state to bail it out is one of the great unknowns of the Chinese economy.

Chinese bank ICBC distributed the WMP and has given out mixed messages on whether it will contribute to a bail-out. ICBC's CDS spreads, which are relatively illiquid (Markit Liquidity Score of 4), widened to 146bps and trade at a 50bps risk premium to the sovereign.

The news from China affected risk assets across the globe, with better than expected PMIs in the eurozone shrugged off. Mixed corporate earnings this week have also had a negative impact on sentiment. The Markit iTraxx Europe was 3bps wider at 75.5bps, with banks bearing the brunt. In North America, the Markit CDX.NA.IG was 2bps wider at 67.5bps.

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