China makes its presence felt

China was once again shaping spread direction in western markets as mixed messages emanated from the world's second biggest economy.

First, the good news. The Markit/HSBC Flash Manufacturing PMI came in at 50.9 for October, up from 50.2 in the previous month and well above consensus estimates. The key sub-indices all performed relatively strongly, with output and new orders at six- and seven-month highs, respectively.

China's slowing growth has been a concern for the markets this year, so a robust reading from this key leading indicator was welcome.

But the optimism was tempered by renewed ructions in the interbank market. The overnight repo rate moved above 4% and the seven-day rate hit 5%, the first time it has done so for four months. The People's Bank of China has withdrawn about 100 billion yuan over the past two weeks, and this reduction in liquidity has probably caused conditions to tighten and consequently pushed rates higher.

Signs that the Chinese property market is overheating prompted Beijing's municipal government to introduce restrictive measures this week, and it is possible other cities will follow the capital's lead. The PBOC's liquidity withdrawal could be seen as the next stage in the government's efforts to reduce debt at the local level.

However, it could also be viewed as a normal liquidity management measure. The rise in repo rates, while significant, is nothing out of the ordinary. China's CDS spreads seemed to reflect the latter opinion. The sovereign's CDS widened 4bps to 85bps, a level within its recent trading range and nowhere near the 140bps reached during the last bout of interbank rate volatility in June (which was exacerbated by QE tapering fears).

European and US markets digested the conflicting news from China, and the main indices saw little change. The Markit iTraxx Europe was slightly wider at 86.5bps, while the Markit CDX.NA.IG widened 0.5bps to 72.5bps.

A lacklustre Markit Flash Eurozone PMI, as well as mixed corporate results, also had to be taken into account. Banks were among the worst performers after Credit Suisse missed estimates and Santander came in below revenue forecasts. In the US, Ford beat expectations while Dow Chemical's results disappointed.

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