Is it policy? China edition This is really worth watching. China's money markets have spiked again after the central bank rebuffed pleas to inject more cash in to the financial system on Thursday, according to the FT. We have the 7-day repo rate jumping 270 basis points to 10.8 per cent, nearly triple where it stood just two weeks ago and overnight money markets hitting silly levels: As we've already written, this may well be policy aimed at WMP's and the interbank market, in particular unregulated bilateral lending between bank branches - essentially an attempt by China to clamp down on those parts of its financial system it has little control over. It's not being helped by slowing capital inflows and seasonal factors but best bet so far is that this is an orchestrated squeeze. (UPDATE: As commenter Beerio notes down below, there appear to be targeted liquidity ops under way. Bloomberg has them supplying Y50bn to a bank with other banks apparently in talks.) As Nomura said: Since mid March, the government has introduced a series of tightening measures in the shadow banking sector to contain financial risks. The cumulative effects of these measures have kicked in. Total social financing dropped sharply to RMB 1.2trn in May from RMB 2.5trn in March. We also got a less than definitive front-page commentary by the China Securities Journal which said: "We cannot use as fast money supply growth as in the past, or even faster, to promote economic growth... This means that authorities must control the pace of money supply growth." And a speech from Premier Li on credit growth. From a different Nomura note (our emphasis): The State Council held a meeting on 19 June to discuss credit policies. Premier Li indicated that the government should provide more credit to high-end manufacturing industries and strategically important new industries and restrict further lending to industries that face severe overcapacity problems. He did not mention the liquidity problem at the meeting, but reiterated the importance of containing financial risks. These messages reinforce our view that policy and liquidity will remain tight, at least before the Q2 data release on 15 July. We do not think the People's Bank of China will cut the reserve requirement ratio to increase the liquidity supply. It would be inconsistent with recent policy signals and the message from Premier Li. Why now? Not sure. Reasons may include: macro data, while weak, is reasonably stable while tight labour market conditions allow some leeway; they want to get in their squeeze before the Fed's; they want to push this stuff ahead of October's big meet; internecine battles within the PBOC. It's also possible this has just got out of control and China has found itself awkwardly sitting between defaults and a bubble, one might say. Or, if one was feeling kinder, between short-term and long-term aims. A final note from Nomura: Will China go into a financial crisis? This is a tricky issue, as the definition of "financial crisis" can differ among investors. We do not think China will experience a crisis like what was experienced in G3 and emerging markets because the banking system is fully controlled by the government, which has the resources to bail out banks, if necessary. In fact, the government has bailed out the banking sector several times over the past 30 years; it last did this in early 2000, when the non-performing loan ratio was 30%. A balance of payments crisis is even more unlikely given China‟s USD3.4trn of FX reserves. Nonetheless, we expect a painful deleveraging process in the next few months. Some defaults will likely occur in the manufacturing industry and in non-bank financial institutions. In particular, we see risks in local government financing vehicles, trust companies, property developers, credit guarantee companies, and leveraged manufacturers in industries with over-capacity problems. The non-performing loan ratio will likely rise, and we expect GDP growth to trend down to 7.2% y-o-y in Q4.