Tough start to the week for Chinese shares.
Mainland equities tumbled ahead of the latest read on GDP from the engine of global growth and trade. The number will come on the heels of the trade data we got last week which betrayed a surprise deficit, the first since February of 2017. That was summarily written off to seasonal effects. As far as GDP goes, “we’ll see what happens” – to use a Trump-ism:
In Hong Kong, it looks like the ongoing efforts to defend the HKD band might be weighing on sentiment. The HKMA has spent something like $1.7 billion over the past several days to keep this from breaking and that seems to suggest there’s more pressure here than a lot of folks expected.
The Hang Seng fell 1.6% to start the week and H-shares were off by more than 2%:
Clearly, the risk is that liquidity tightens up and rates rise as the HKMA copes with persistent pressure on the currency and the worry is that that ends up cascading and undermining the country’s property market, with God only knows what ramifications for the rest of the local economy.
If you’re super interested in this, city financial secretary Paul Chan penned a blog post over the weekend that we’ll excerpt below for you to peruse at your leisure.
Via Paul Chan
Hong Kong Exchanges recently weakened. As expected, on Thursday, it touched the 7.85 level of the weak party guarantee. The HKMA bought the Hong Kong dollar and the US dollar from the market. This was the first time that the linked exchange rate system had been introduced into the market since the introduction of optimization measures in 2005. At the time of writing, the HKMA has accepted the Hong Kong dollar offer four times and bought approximately HK$9.66 billion.
I said that this was “as expected” because I did not have a crystal ball. In fact, I and a number of financial officials of the government have repeatedly noticed in the past that the US Federal Reserve Bureau has raised interest rates six times since December 2015. The spread between Hong Kong and the United States has obviously widened, attracting “arbitrage transactions” that will cause the Hong Kong dollar to flow to the United States dollar. Eventually, some funds will flow out of Hong Kong and provide conditions for the normalization of interest rates. However, everyone does not need to worry too much about the flow of Hong Kong dollars for two reasons:
First, automatic adjustment within the design
The linked exchange rate is a currency board system. In simple terms, when there is a capital outflow in Hong Kong and the exchange rate is weak, until the level of the weak exchange guarantee (7.85) is touched, the HKMA will buy the Hong Kong dollar and the US dollar from the market, ensuring that the Hong Kong dollar will not be exchanged. Weaker than 7.85. With the flow of funds out of Hong Kong, the Hong Kong banking system will have a surplus. When it falls to a certain level, the bank will increase the Hong Kong dollar interest rate based on commercial considerations and its own needs. This is the normalization of interest rates that we often hang around. When the Hong Kong dollar interest rate rises and the gap between the interest rate and the interest rate is reduced, the outflow of funds from Hong Kong exchanges will naturally slow or even stop. Hong Kong exchanges will also stabilize. Therefore, the “four steps” that emerged from the linkage design: capital outflows → shrinking balances, rising interest rates, and stable exchange rates are all normal operations within the mechanism design.
Second, make preparations for strong earthquake resistance
People who have experienced the Asian financial crisis in 1997 may worry that the funds flow out of Hong Kong this time. Does the government have enough financial resources to cope? The answer is unquestionable because we are ready early. Since the implementation of quantitative easing in the United States in 2009, a total of US$130 billion has flowed into Hong Kong. The HKMA puts this amount of funds equivalent to about 1 trillion Hong Kong dollars into a number of highly liquid and credit quality US dollar assets (such as US Treasury bills) that can quickly become cash in US dollars. Even in the face of extreme situations, large sums of money are required to buy Hong Kong dollars and buy US dollars. The HKMA will absolutely be able to meet these exchange requirements. The current Hong Kong dollar currency base is about HK$1.7 trillion. It also has the above-mentioned dollar assets support, which provides a great buffer for the outflow of funds.
In addition, we have also taken precautions to prevent earthquakes. We have already done a good job of preventing earthquakes in the banking and financial systems of Hong Kong before the funds ebbs. For example, the HKMA has continuously strengthened the risk management of banks and conducted stress tests for banks to raise awareness and preparation for the banking industry. . Local banks in Hong Kong held high liquidity assets of more than HK$4 trillion at the end of 2017, and the liquidity coverage ratio of banks was close to a high level of 150%, which can provide sufficient buffer for the flow of funds. In addition, there are abundant exchange funds to provide a stable backing. In fact, Hong Kong’s financial and banking systems have always been highly resilient and Hong Kong has survived the global financial crisis in 2008 and the European debt crisis in 2011. Therefore, I am very confident that Hong Kong can cope with the huge flow of funds under extreme circumstances. The challenges that arise.
Rising interest rates are unavoidable
As mentioned earlier, according to the “four steps” of the Link, when funds begin to flow away from the Hong Kong dollar, Hong Kong interest rates will rise. In fact, since interest rates in Hong Kong have risen since the United States began to raise interest rates, the one-month interbank rate, which is often used as a benchmark for building mortgages, has risen from 0.22% at the end of 2015 to the latest 0.85%. After the outflow of funds, the Hong Kong dollar interest rate will be closer to the US interest rate. Even if the current Hong Kong dollar interest rate spread does not appear to be in a short period of time, there will be no sharp increase in the interest rate, and borrowers’ interest expenses will inevitably rise.
Take precautions to manage risk
The public should adopt a pragmatic and prudent attitude when borrowing money. We should not expect that the ultra-low interest rate environment will continue unabated. We must carefully consider whether we can cope with the increase in interest expense on loans, and we must also pay attention to the increase in interest rates to asset prices. The possible influence of your own investment, the ability to do it, careful management of risk.
April 15, 2018