CDS Tale of a Giant (China) and a Dwarf (Greece)

17. February. 2010

The past week has seen the problems of a small southern European country writ large on the global stage as the world weighs whether contagion or moral hazard is the more important enemy to battle.

So while the world watches the woes of a country with 11MM people, a country with 1 bilion has tapped the breaks three times since we entered 2010. The first came on 1/7 when the People’s Bank of China raised the interest rate on its three-month treasury bills by 0.04%. The second time was on 1/18 when the central bank increased reserve requirements by 0.50%. The third time was last Friday when the PBoC raised its reserve requirement by another 0.50% bringing the percentage of deposits banks have to keep on hand to 16.5%.

The move on the 18th was part of a triple whammy to hit the U.S. stock market, accompanied by Obama’s banker bonus bashing and the bumbling of Bernanke’s 2nd term confirmation. This troika set of the correction that brought the S&P 500 from 1150.23 on 1/19 to 1056.74 on 2/8.

Stocks in China also dropped on each of the days the People’s bank took action but China’s economy doesn’t seem to care. Evidence of this was corroborated by data released Friday that electricity demand rose by 40% in January alone and appears to be pushing the limits of existing infrastructure.

Two separate purchasing-managers indexes also showed increased activity in manufacturing with the HSBC China Manufacturing Purchasing Managers Index (3 times fast please) rising to a record of 57.4 in January from 56.1 in December. The China Federation of Logistics and Purchasing and the National Bureau of Statistics index came in at 55.8, down slightly from December’s 56.6 reading but still comfortably above the 50 mark which determines whether the economy is expanding or contracting.

As for Friday’s efforts to slow things down, Mark Williams with Capital Economics in London said, “The first signals that the People’s Bank were tightening made big waves in the markets around the world, because the China recovery has been such a big part of the global story over the last few months,” adding “I wouldn’t expect this move to have anything like the same impact.”

With regard to how these moves are impacting the Middle Kingdom’s economy, Wang Tao, UBS’ China economist said, “Even if new Yuan loans were under control, liquidity in China’s real economy remained ample last month, which supported the manufacturing activity.”

The central bank’s efforts to rein in lending “is creating some concern here that they might slow down their economy so much that it impacts the global rebound,” was how Robert Pavlik, chief market strategist at Banyan Partners in New York, described the reasoning behind the world’s reaction to the rate hikes.

As with many things, the tightening seems to be relative as new local currency loans totaled 1.39TN Yuan ($203.6BN) in January, nearly 1/5th of the governments lending target for the entire year. With property prices up 9.5% in the first month of 2010 it would seem prudent to slow things a bit. Fortunately consumer price inflation moderated to 1.5% in January from 1.9% in December so there might not be the need to really slam on the brakes.

Additionally, the National Development and Reform Commission, the agency responsible for economic planning, predicted that oil will average around $80/bbl this year, up about 25% from last year and reinforcing analysts’ expectations that Chinese demand will continue to help push prices up despite concerns that recent credit tightening moves could crimp its demand for oil.

China’s apparent energy appetite rose 15% YoY in December and Harry Tchilinguirian, senior oil analyst with BNP Paribas, thinks that “with growth front-loaded in 2010, the progressive tightening won’t bear much impact on oil demand in the first half of the year.”

Sounds like the growth news out of China will more than make up for the gross debt issues out of Greece.

5-yr CDS levels for Greece retreated last week falling from 425bps on 2/8 to 355 on 2/12. For a little perspective, it should be noted that in August of last year, default protection cost just 100bps on Greek debt.

CDS levels for China’s sovereign paper closed at 85bps on Friday. CDS levels in this market have been range bound since May of last year with a high of 92bps (11/27/2009) and a low of 59bps on 9/23/2009.

Enjoy the holiday shortened week.
[Seeking Alpha, by: Jim Delaney]