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Middle Kingdom

27 January 2020 by jbchevrel

The corona-virus theme kept rattling CDS markets. We previously examined this trading theme from two different angles (oil sector, Europe vs US) in this blog. Let’s now focus on the epicentre of the crisis. The China 5y CDS widened another +5.625bp today, closing at 42bp. Market participants are grappling with what the actual GDP impact can be. Firstly, we don’t know when it is going to stop. On that question, some experts have predicted that the corona-virus has now entered a steeper phase of growth, which could reach a peak in March, and then flatten back in May. This is based on the SARS epidemic, back in 2003. Indeed, the 1st case of SARS was reported in December 2002, and the last case was referenced in May 2003. The fact that this happens on Chinese New Year holiday is obviously key, and this is another similarity with 2003 SARS. As far as the travelling sector alone, for reference, ~3b trips had been booked during the period. More generally, consumption should be the worst affected part of the economy. Back at the time of the SARS, the pace of retail sales had been divided by ~2 between Dec 02 and May 03. We may well see the same kind of path there. Despite that, the total China growth was +9.1% in 02 and +10% in 03. Making the SARS not remarkable. Now, the difference between back then and now is that back then consumption was a smaller chunk of GDP. Back then it was less than a third, while now its not far from half. Also, China growth was much steeper back then, no matter what, with double-digit investment growth. However, on the positive side of things, nobody doubts these days that the PBoC will stand ready to act to support growth, in case the government’s targets are at risk. Hence why, we could see (even) lower rates there (RRR, MLFR, LPR..) and (even) more liquidity flowing into the system.