Hong Kong becomes the world’s must-watch market

For global investors attempting to gauge the fallout from surging interest rates and easing back economic growth, Hong Kong is rapidly arising as a must-watch market.

Maybe no place else is as presented to two of the biggest concerns global asset prices – the Federal Reserve’s quickly tightening monetary policy and China’s faltering economy.

While Hong Kong’s US$466 billion (S$651 billion) foreign reserve stockpile and ample interbank liquidity recommend little chance of an inescapable emergency, indications of financial stress are building.

This week saw the city intervene to set up its pegged currency for the first time beginning around 2019. Its stock market has tumbled for this present year at one of the fastest rates globally. Home costs in the world’s most un-reasonable property market are falling and indications of capital flight are multiplying, after portfolio outflows last year topped US$100 billion for just the second time since Hong Kong’s 1997 handover to China.

“There is a lot the city can do to stabilize the financial system when capital inevitably flows out,” said Dr. Rujing Meng, who lectures on finance at the University of Hong Kong. “What is difficult to predict is how bad sentiment can get globally. Things could get very volatile and systems could break before people get used to quantitative tightening. Hong Kong can’t be immune to that.”

The city has for over a decade ridden a wave of modest cash swelled by central bank stimulus. Its organizations localized funds to meet their liquidity needs when the global credit press grabbed hold in 2008. China’s economic boom pulled capital into the city as mainland firms raced to sell new shares. An expected US$130 billion streamed in after the Fed started quantitative facilitating in late 2008, as indicated by the Hong Kong Monetary Authority (HKMA).

Investors stopped their money in the city given its somewhat protected and effectively convertible currency. The wealth of cash implied that in any event, when the Fed brought acquiring costs up in the 2015 to 2018 cycle, local rates remained moderately low. The aggregate balance – a measure of interbank cash supply in Hong Kong – is 70 times greater than it was before the global financial crisis.

The result of quantitative facilitating has been a property bubble, with residential costs rising 237% from 2008 to a record in August last year, Centaline information shows. About US$6.5 trillion was added to Hong Kong’s share values, permitting the city’s stock market to briefly surpass Japan’s as the world’s third-biggest.

Presently, the flow of capital is heading down the other path. Among the world’s worst performers even before the Fed raised interest rates, Hong Kong’s Hang Seng Index lost 40% in the year till March 15. Financial non-reserve assets dropped by a net HK$379 billion (S$67.5 billion) in 2021 – identical to 13.2 percent of the city’s gross domestic output – as portfolio outflows outweighed direct investment.

The outflows are eating into Hong Kong’s emergency cradles. The city’s foreign reserve resources dropped for five consecutive months, including a US$15.9 billion decay for April. Hong Kong’s wealth fund lost US$7 billion in the first quarter as the worth of stocks and bonds declined.

Liquidity in the financial system is keeping the city’s interbank rates low until further notice, while those in the United States are rising quickly. That makes it profitable for currency traders to get in Hong Kong dollars and buy assets in the higher-yielding US currency. The carry trade, which was likewise well known in 2019, will go on until the HKMA’s liquidity drainage causes Hong Kong’s interbank offered rates to find their US equivalents.

Whenever that occurs, watch the property market, where residential costs have fallen 4.5 percent since August. Hong Kong banks last week kept up with their best lending rates – which they use to quote mortgage loans – even as the HKMA expanded borrowing costs. Lenders can do that since they acquire efficiently from each other. In any case, economists at DBS Bank predict that one-month interbank rates will be around 200 basis points higher than current levels by the year-end.

As a small and open economy, Hong Kong is particularly vulnerable to cash streaming in and out. It was hit hard by the Asian financial crisis that began in Thailand in 1997 and spread across the region, compelling the HKMA to purchase Hong Kong stocks and use foreign currency reserves to defend the dollar stake. House costs tumbled 70%.

Today, the city is better outfitted to manage external shocks, even as pressure works in basically all that across markets around the world, from falling stablecoins to one of China’s largest developers defaulting for the first time. The HKMA this week repeated that the linked exchange rate system – a currency peg that has gotten through generally solid for right around 40 years – is working great.

“Hong Kong just has to see this year though,” said Mr. Samuel Tse, an economist at DBS in Hong Kong, adding that he expects that the city’s banks should not lift prime rates until the second from last quarter.

“I would expect things to stabilize by then,” said Mr. Tse. “The stock market will recover, Chinese relistings will bring in capital and money will come back in. This won’t be the end of flush liquidity in Hong Kong. Not this time.”