The CDS market was hit by a perfect storm today as a number of factors combined to send spreads sharply wider.

China has faded into the background this year, at least from a global perspective, as developed market central banks took over the agenda. But it has roared to prominence again due to growing signs of severe stress in the interbank market. Funding rates have spiked upwards, with the one-day repo rate climbing to over 12%, a new record.

The People's Bank of China (PBOC) typically injects funds when interbank liquidity is getting squeezed. But it has refrained from doing so on this occasion, and its reticence has created fears of a potential credit crunch. The PBOC's motives are unclear, but it is possible that the central bank is signalling it is no longer willing to support rampant credit creation.

Lending through the "shadow banking" system has increased dramatically over the last four years, often in the form of wealth management products issued by off-balance sheet vehicles. Leverage has risen across the economy as a result, and it could be that the PBOC is finally taking away the punchbowl. It is also possible that it is coming under political pressure - the new regime in Beijing has stated clearly that it wants to rein in the excesses of recent times.

Will the PBOC continue to stand firm or will it soon relent? There are already reports that the central bank has injected funds to one bank today, and it still has a role as the lender of last resort. But it is also true that China has a debt problem, notably at local authority level and among property developers, and this will need addressing at some point. If there is a prolonged restriction on liquidity, it will inevitably lead to bankruptcies and impinge on growth.

China's sovereign CDS widened 33bps to 133bps, a massive move by its standards. In fact, the only periods when it has seem moves of such magnitude were the peak of the financial crisis in 2008-2009 and September 2011, when there was widespread talk of a "hard landing". That didn't materialise, and spreads soon recovered. If the pattern is to be repeated, the authorities will need to rediscover their interventionist instincts.

To make matters worse, the Markit/HSBC China Flash Manufacturing PMI came in at 48.3, a nine-month low and significantly worse than expectations. The GDP growth rates of 10% and above now seem a long way away.

Important as China is, it was the actions of the US Federal Reserve that were the main driver of today's capitulation. The Fed sent a clear signal that it is preparing to scale back QE, although it did stress that this was dependent on labour market data continuing to improve. Ben Bernanke indicated that the central bank is unconcerned about the recent rise in Treasury yields; indeed, he regards this as an indication of economic strength.

So it looks like the dreaded QE tapering may be on its way this year, and will be finished by mid-2014 if Fed projections prove correct. The market reaction suggests that many investors believe this is premature: the recovery remains fragile by historical standards and unemployment is still high. An improving US economy - which the Fed expects - is to be welcomed, as long as it doesn't get choked off by rising Treasury yields.

European credit markets experienced their worst day since November 2011. The Markit iTraxx Europe was 12.5bps wider at 120bps. Commodity names were the worst performers, with Glencore (300bps, +62) and Anglo American (224bps, +50) suffering a torrid time. Emerging market sovereigns were in full retreat, and we can expect considerable volatility in the days ahead. The tone for the summer has been set.

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