Risk Of Hard Landing In China Is Very Real: Credit Suisse

Financial markets have been in a Risk Appetite "panic" so far this year
Global Risk Appetite Index (Source: Credit Suisse via ValueWalk)

A Credit Suisse report considers the world economic picture and is concerned about China and its currency, voicing speculations that “Chinese authorities risk ‘losing control’ of the economy.” The impact of China on the world economy, a hot topic particularly as global markets have crumbled year to date, could ultimately lead to “substantial implications across the investable universe.” In particular, this could impact a U.S. Federal Reserve interest rate hike under a worst case analysis.

The report starts off stating:

Our central scenario remains for a further controlled moderation in Chinese growth this year; however, we think that the risk of a more severe correction has grown substantially, as the effectiveness of the export/investment/credit- intensive growth model is increasingly brought into question (both by markets and domestic policy makers).

Credit Suisse: “Risk of a more severe correction has grown substantially”

Credit Suisse’s January 15 report, titled “China: The Year of Living Dangerously,” re-iterates the central scenario expectations for “controlled moderation in growth” for China in 2016. However, the report notes that “the risk of a more severe correction has grown substantially.”

The report, from the bank’s Global Markets Research team in Asia, raises concerns in the area of effectiveness in export, investment and credit growth models that is increasingly brought into question by both markets and domestic policy makers.

“We believe that even under our central scenario of a controlled slowdown, many China-related assets will remain under pressure, with the occasional inevitable data undershoot or Chinese policy change likely to lead to periods of heightened volatility,” the report predicted. “The risk of contagion to other markets has been exacerbated by concerns about the strength of non-China global growth, with stresses in US credit markets and, more recently, global equity markets adding to the negative sentiment.”

CS 1 15 China chart

China – Bank’s Global Risk Appetite Index at “Panic,” and odd reading given the absence of a significant near-term event catalyst

As it stands, the bank’s Global Risk Appetite Index has returned to a level defined as “ Panic,” a “rare” reading outside of major events in the global economy, the report stated. The U.S. Federal Reserve hiked rates in mid-December, as widely anticipated, and China’s most recent stock market fall in valuation only really accelerated after the start of the New Year.

“As growth slows, the inevitable occasional data undershoots, or perceived policy missteps, are likely to result in further periods of financial volatility across global markets,” the report predicted, leading to a correlation around the world. Credit Suisse believes the risk of a more severe correction has grown substantially during the recent months as the U.S. Federal Reserve tightened interest rates and global stock markets appear in sell-off mode,

The issue from a global growth standpoint are how weak growth influences the rest of the world relative to trade, asset prices and market expectations. This leads the bank to an ominous conclusion.

In regards to a hard landing, the bank warns:

There is a real risk of the catalysts for a hard landing materialising. If house prices fall 15% or more, capital outflows cannot be controlled or the loan-to-deposit ratio hits 100%, then we think a hard landing risk becomes very real in China. This, we think, could initially send equites down by 10%-20% from here.

“The intensification of credit market stress, the further decline in commodity prices, and renewed uncertainty about China’s FX regime and capital flows now raise the possibility that deteriorating global expectations will bring forth a more meaningful shock,” the report warned.