Specifically, people worry that the reigning in of the credit markets could lead to a disorderly economic slowdown. This could mean that GDP slows to a sub-5% level from 7.7% in 2013.
Currently economists see GDP slowing to 7.4%.
“Hard-landing risks may be moderate but not low enough to make hedging costs irrelevant,” said Viktor Hjort of Morgan Stanley’s cross-asset research team. “Uncertainties are high as the Chinese financial system faces deleveraging. We’re not in the hard-landing camp but we also recognise that a hard landing would have major implications for many markets and in particular the most China-sensitive assets in equities, credit, rates and FX in Asia. On our estimates, markets are pricing in a 1-in-15 chance of a hard-landing in China in the coming twelve months — more so in equities and less so in FX markets.”
1-in-15 reflects roughly 6% odds of a hard landing. Earlier, Societe Generale’s Wei Yao forecasted a 20% chance of a hard landing.
According to Hjort’s analysis, hard-landing risks are being priced in unevenly across the options markets.
“Our preferred hedges are those markets that price in the least hard-landing risk,” he wrote, emphasising that non-US options are intended for institutional clients. “FX puts (CNH and AUD in particular) and KRW rates 1y1y receiver swaptions look most compelling on our analysis, with credit and equity hedges generally more expensive.”