The last four weeks have seen a significant repricing of money market liquidity in China with the 1 month SHIBOR rate surging from 3.25% on May 15th to 7.16% this morning. There is little doubt that a good portion of this rise is due to seasonal factors since money markets historically tighten towards the end of the second quarter as companies start to window dress their balance sheets by hoarding cash. However, the average rise in 1 month SHIBOR between May 15th and June 18th over the last 5 years has been 100 bp (from 2.77% to 3.77%), which hardly compares to this years 391 bp increase (see attached chart).

Only 2011 saw a similar surge in money market rates, but back then the PBOC was at the height of its macro-prudential tightening and the Eurocrisis was causing a general tightening of global money markets. We would therefore conclude that liquidity conditions have started to worsen considerably in recent months despite the fact that credit creation, at least through April, remained at record pace, and were reduced but still buoyant in May. This is perhaps the first sign that the clampdown on wealth management products is having a tangible effect on Chinese liquidity conditions, but we also note that the IPO market for Chinese corporate credit has suddenly started to be much less receptive to new issues, cutting off a second source of "shadow banking".

Meanwhile the news that house prices have risen in 69 of the 70 largest Chinese cities represents a serious constraint on the PBOC's ability to address the strains of the money market and we doubt any dramatic moves will be taken. Money is therefore likely to remain very tight through the end of the quarter and even though we would expect to see SHIBOR rates fall sharply thereafter we do not expect them to settle back down at their April/May levels.

Should June's Social Funding and Loan data confirm our concerns then the clock would begin ticking on the effects of a severe credit crunch becoming apparent in Chinese economic activity, with the lag likely to be around 6 months based on the experience of other cycles.