Photographer: Xaume Olleros/Bloomberg

Hong Kong’s Money Market Squeeze Sends Sell Signal on Stocks

  • Funding costs increase for 11th day to seven-year high
  • Credit crunch signals concern about cash exodus, ANZ says

As pressure in Hong Kong’s money market builds, the risks to the city’s equities and currency are mounting.

Funding costs surged for an 11th day on Tuesday to a 2009 high as the Federal Reserve prepares to tighten monetary policy, making it more expensive to borrow to buy stocks. With the squeeze starting to spill over into other markets, Australia & New Zealand Banking Group Ltd.’s Raymond Yeung says it’s signaling concern about a cash exodus.

“Higher U.S. bond yields will cause outflows from emerging markets and Hong Kong," said Yeung, chief greater China economist at ANZ in Hong Kong. “The influx of investment flows from the mainland into Hong Kong motivated by currency hedging can offset some pressure. Yet, the interbank market has started to price in potential outflows."

Investors still seem relatively sanguine about the situation. Implied volatility in stocks is near a 20-month low, home prices are once again headed toward record highs, and the exchange rate is holding near the strong end of its band against the greenback. While higher borrowing costs are, in isolation, a support for Hong Kong’s dollar, previous bouts of outflows have led to currency depreciation along with a jump in rates.

In January, the Hong Kong dollar plunged to an eight-year low as fears of a yuan devaluation roiled global markets. Goldman Sachs Group Inc. predicted in a note on Tuesday that Hong Kong’s exchange rate will fall to the weak end of its 7.75 to 7.85 band while local rates will catch up with U.S. levels after the next rate hike by Fed, which is widely expected to occur this week. Hong Kong’s dollar fell as much as 0.06 percent on Friday, the most since July, to 7.7599 per U.S. dollar after the greenback jumped.

The city’s government bonds slid on Tuesday, with the 10-year yield jumping 17 basis points to 1.74 percent, the highest for benchmark notes of that tenor since January. Points on Hong Kong dollar forwards turned positive on Monday as they surged to a 10-month high, signaling expectations for local rates to exceed U.S. dollar levels.

Narrowing Gap

Hong Kong’s three-month interbank rate, or Hibor, rose four basis points to 0.87 percent on Tuesday. The move narrowed Hibor’s gap with Libor, the U.S. equivalent, to nine basis points; just two months ago, the spread was thrice that and the widest since 2010. Higher Hong Kong rates will help to discourage outflows and thus stabilize the local dollar, said Marvin Chen, an analyst at JPMorgan Chase & Co. in Hong Kong.

"Even with two expected U.S. rate hikes next year, the rate gap with Hong Kong won’t be wide enough to spur significant outflows," said Thomas Shik, acting chief economist at Hang Seng Bank Ltd. Investors also like Hong Kong because of its currency peg with the strong greenback and Asia’s higher growth potential, he added.

Stocks, Insurance

There are money-market concerns on both sides of the Hong Kong-mainland border. The Shanghai Composite Index retreated the most in six months on Monday as concern about dwindling liquidity was exacerbated by a regulatory crackdown to insurers’ stock investments and Donald Trump’s remarks about the U.S.-China trade relationship. Hong Kong’s Hang Seng Index eked out a slight gain on Tuesday, after closing at a three-week low on Monday.

Hong Kong’s financial secretary John Tsang resigned from his position on Monday, spurring speculation he’d run for the city’s top leadership post next year. Chief Executive Leung Chun-ying said last week he wouldn’t seek a second term.

Currency weakness, along with concern mainland assets are overpriced, has driven Chinese investors to put their cash in Hong Kong equities and homes. China is now stepping up restrictions on outflows to defend the yuan, including tightening curbs on its citizens buying insurance in Hong Kong. The city has also raised its stamp duty to rein in its world-topping home prices.

“Inflows from China may slow because of recent measures," said Steven Leung, Hong Kong-based executive director at UOB Kay Hian. "Hong Kong hasn’t seen outflow pressure, but next year it will be more obvious."

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