China Stocks Tumble Most In 4 Months; Australia Cuts Rates To Record Low

Yesterday, when we heard that China brokers may impose tighter margin requirements to contain what is now a laughable stock bubble we said that tonight's Shanghai session could get exciting:

It did: overnight the Shanghai Composite tumbled by 4.1% to under 4300, the biggest one day drop since January 19.

Additionally, the Shanghai Stock Exchange Property Index falling 8% although keep in mind that the sub-index added 52% in 3 months to end-April on relentless hopes of central bank easing the worse the economic data got. The rout also spread to Hong Kong where the HSI dropped as much as 1.9%, down 4th day in longest loss streak since March 11.

While it is too early to know if the Chinese stock bubble has finally burst, it is just as unclear what precipitated the selloff. On one hand Reuters attributes the drop to the previously noted collateral concerns saying "media reports of tougher margin requirements by some brokerages added to concerns about market liquidity ahead of a new batch of share listings." Specifically, brokerages such as CITIC Securities Co Ltd, Haitong Securities Co Ltd and Huatai Securities Co Ltd tightened requirements for margin financing this month in a bid to control risks, the Shanghai Securities News reported on Tuesday.

This is major concern for China where the unprecedented jump in margin debt coupled with an explosion in new accounts has been the primary driver behind the relentless rise in the Shanghai Composite. "The move could curb money inflows in a highly-leveraged stock market rally. The outstanding value of margin financing - the amount of money investors have borrowed to buy stocks - has exceeded 1.8 trillion yuan ($290 billion) and repeatedly smashed records in recent sessions."

"I suspect the brokerages are doing so under the guidance of regulators, so this reflects regulators' intentions," said Zhang Chen, analyst at Shanghai-based hedge fund manager Hongyi Investment. "It gives an excuse for some investors to take profit."

Additionally, liquidity has been soaked up by a flurry of new IPOs with the market grappling with short-term liquidity pressures as nine companies start taking subscriptions from investors on Tuesday with more scheduled to launch share sales later this week. Altogether, subscription for new batch of A-share IPOs is expected to peak today with a total of 25 IPOs in early May estimated to drain 2.34 trillion in yuan of liquidity according to Bloomberg calculations.

All of this follows a move by the RBA in which the Australian central bank cut rates as expected from 2.25% to 2.00%, a record low.

Rising property prices in Australia's biggest city, Sydney, a strong currency and a drop in iron ore prices were among the reasons for the cut.

The cut is the second this year, following a previous 25 basis point cut in February.

Here is Goldman's take:

Bottom Line: As expected, the RBA cut rates by 25bp in May, but a subsequent initial ~US40c rally in the AUD suggests financial markets viewed the lack of an explicit easing bias in today’s brief statement in a relatively hawkish light. In our view, however, it is important to acknowledge that in months where the RBA changes the policy rate it tends to reflect more on the decision itself and does not always communicate a clear forward-looking reference in the statement attending the decision. This was the case in February 2015, for example – with an easing bias more clearly articulated not long after that. In turn, and with the RBA’s current economic forecasts already calibrated on further easing in any case, we would not be surprised to see an easing bias expressed more explicitly in Friday’s Statement on Monetary Policy (SMP; if a more moderate one).With May’s rate cut closely following 1Q2015 CPI, we also believe the timing of today’s decision underscores the importance that the RBA places on actual CPI outcomes in framing its outlook for inflation – raising the risk that the rate cut we currently have penciled in for July is delivered a month later in August (following 2Q2015 CPI). In the interim, we expect Friday’s SMP to reveal further growth downgrades, and to continue to refocus attention on trends in household demand (as opposed to broader measures of aggregate demand). All in all, we believe the coming months will see ongoing benign inflation and note that our proprietary indicators are flagging downside surprises on the growth/employment front. Against the backdrop of the rising risk of slippage in the timing of the rates lift-off in the US, we continue to lean towards another rate cut this year.

What was clearly notable about this particular rate announcement is that it was not frontrun by HFTs....

... unlike previous occasions...

... even though as a reminder Australia's regulator found no illegal activity previously and merely blamed lack of liquidity on the massive, and directionally correct, moves:

Preliminary findings reveal moves in the Australian Dollar ahead of the announcement to be as a result of normal market operations in an environment of lower liquidity immediately ahead of the RBA announcement. The reduction in liquidity providers is a usual occurrence prior to announcement in all markets. Much of the trading reviewed to date was linked to position unwinds by automated trading accounts linked to risk management logic and not misconduct.

And here we thought that HFTs add liquidity.

In any event, even if one had known the statement in advance, that subsequent move in the AUD was such that pretty much everyone's stops were taken out first to the downside, and then to the upside.

Most surprisingly, despite the rate cut, Australia's ASX200 index closed just a fraction in the red.