Fed focus to dim China worries but plenty more twists and turns still to come

Expect more testing times to follow with regards to China

The market looks to be breathing a sigh of relief on the day as the Evergrande episode has not gotten much worse this week, as the company is said to make coupon payments for its onshore bonds due tomorrow.
The Shanghai Composite has pared earlier losses to turn positive now as US futures also pull slightly higher on the day, up between 0.3% to 0.4%.
Given prevailing sentiment, the focus in the day ahead will turn towards the Fed next but don’t expect this to be the end of China worries. As mentioned yesterday:

The main focus in the market continues to be on China in general but there are many opinions flowing through that Evergrande isn’t going to be the next Lehman Brothers.

There are plenty of valid points in that regard and I don’t expect China to risk any major collapse of its financial system but that doesn’t mean that local authorities are going to put a stop to the whole saga come tomorrow.

Evergrande is on the brink and it is clear that the company is being made an example as China looks to “clean up” key sectors in the economy. The issue with Evergrande is debt and what began with leverage problems will end with a sale of assets in all likelihood.

State players may intervene to try and smoothen the process and clear some of the bad dealings but the whole Evergrande episode is going to be a long and drawn out one, so don’t expect a quick fix to the turbulence in Chinese markets.

Adding to that is the government also cracking down heavily on other key sectors besides property/construction and that makes for plenty of volatility and risks to go around.

Contagion may not play out in the most obvious spots but best be wary in case it does start to put a drag on market sentiment globally if the reverberations are loud enough – such as the episode that we saw in trading yesterday.

China will do what it can to keep domestic markets comforted by providing sufficient liquidity (watch for the PBOC tomorrow) but don’t expect any direct responses in putting a halt to all the fear and anxiety.

The market will have to eventually realise that China has shifted to a new paradigm, and it is one that we will all have to learn to trade around in the years to come.

The PBOC already stepped in today with a big chunk of liquidity injection and while there is a perceived calm throughout, there have already been significant reverberations from this whole episode to China’s high-yield market as well as the construction and financials sectors amid the ongoing risks posed by Evergrande itself.

More distressing signals such as a funding stress may not be playing out (yet) but that doesn’t mean that we’ve made it through all the turbulence.
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