Fed Preview: Tapering Fears Overdone, China the Real Threat

A note from the equity strategy team at Credit Suisse this morning previewing the Fed decision this afternoon shockingly played down worries of the Fed tapering purchases and instead highlighted that China slowdown fears are well under-appreciated by the market. They are also less concerned with the recent turbulence in Japan than most investors.

Fed Preview

"In general, we believe that investors have overreacted to the Fed minutes," wrote the strategy team led by Andrew Garthwaite in London. Our US economists believe that the Fed will start to reducing their asset purchases to $65/bn a month in September (compared to the current $85/bn) and stop purchases altogether in H2 2014."

The believe that the turbulence in markets since Bernanke's May 22 testimony on capitol hill, where he first directly addressed tapering, make it all but impossible for the Fed to begin tapering now. "The mixed data and market jitters since Chairman Bernanke's May 22 JEC testimony argue for a delay in tapering. We maintain our longstanding view that the best opportunity to scale back the pace of asset buying may not come until later this year – perhaps in September," wrote chief U.S. Economist Neal Soss.

Do note that a de facto monetary tightening has already occurred in the market, as mortgage rates have risen about 0.7 percent since Bernanke's speech. Further, GDP indicators point to about 2.3 percent growth, not nearly enough to accelerate the pace of hiring, while inflation expectations remain at low levels.

Japan Fears Overdone, China Should Be In Focus

They do reiterate their stance that Japan fears are overdone while investors are under-appreciating the risk posed by China to global markets. However, Bank of America's fund manager survey yesterday showed that China fears had increased in the last month.

Credit Suisse notes the fact that PMIs have not been accelerating despite upticks in loan growth and lending rates, the so-called SHIBOR rates that have been widely publicized. SHIBOR is the equivalent of Libor for Chinese lending rates.

The increasing cost of credit in China despite the growth in loans points to a massive liquidity squeeze in the country. "We believe that concerns over Japan are overdone (note that Nikkei open interest has fallen to October 2012 lows) – but we are much more bearish than the consensus on China. Half of global GDP growth has come from China and we are relatively bearish on China's growth prospects."