Crisis Gauge Rises to Record High as Swaps Avoided – Bloomberg 02-26-14

Salient to Investors:

The spread between the 2-yr China sovereign yield and the similar-maturity interest-rate swap, a gauge of financial stress, last week reached the widest in Bloomberg data going back to 2007.

George Soros and Bill Gross have drawn parallels between the situation in China and that in the US before the 2008 financial crisis. Nomura said Li’s efforts to curb leverage by driving up borrowing costs need to be handled carefully to avoid wrecking confidence in the financial system.

Patrick Perret-Green at ANZ Banking sees increasing parallels between China and the US in the run-up to the global financial crisis – Shibor-repo is similar to Libor-OIS, shadow banking is subprime, credit spreads are widening as they did in 2007, and money growth is softening as tightening bites.

Wee-Khoon Chong at Nomura said there is a big flight to quality: in times of stress, you sell credits, sell longer-dated bonds into shorter ones and you are going to the government bond market. Chong said if the default situation gets out of control, yields are going to fall a lot, and forecasts the central bank will cut reserve-requirement ratios for lenders to 19 percent this year from 20 percent as higher borrowing costs cool economic growth.

Bin Gao at Bank of America Merrill Lynch said a consistent rally in sovereign debt will be more likely if we see more defaults in shadow banking or credit products, which will lead to flight-to-quality flows and likely PBOC easing.

Yii Hui Wong at BNP Paribas said increased money-market turmoil and the outlook for slowing growth are serving as catalysts for a rally in government bonds as banks increase buying – the rise in the short-end will spread to 5-yr notes. Wong said offshore investors take a longer-term view, and do not feel that the government cannot handle the situation because it is still a very controlled economy. Wong said government bonds at these levels are very attractive.

Read the full article at http://www.bloomberg.com/news/2014-02-26/crisis-gauge-rises-to-record-high-as-swaps-avoided.html

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