Macro + Rates Strategy

Transcription

1 Global Economics & Markets Research URL: Macro + Rates Strategy Suan Teck Kin, CFA Head of Research Suan.TeckKin@uobgroup.com Heng Koon How, CAIA Head of Markets Strategy Heng.KoonHow@uobgroup.com Peter Chia Senior FX Strategist Peter.ChiaCS@uobgroup.com Victor Yong Rates Strategist Victor.YongTC@uobgroup.com HKMA sold USD as HKD hit the weak side of the Convertibility Undertaking, as designed, and this should not raise undue concerns about the HKD linked exchange rate system (LERS) We continue to expect the HKD link system against the USD to remain for the foreseeable future, based on the following three key factors: institutional arrangement, time tested history, and strong domestic economic fundamentals However, higher domestic interest rates as a result of the functioning of the LERS could pose risks to the asset markets and we expect HKMA to lean towards guiding local rates higher in a gradual and controlled manner HKMA Sold USD As HKD Hit Weak-Side Of The CU With the HKD hitting the weak-side of the Convertibility Undertaking (CU) of 7.85, the Hong Kong Monetary Authority (HKMA) in the week of April bought in a total of more than HKD51 billion worth of Hong Kong dollars, in accordance with the linked exchange rate system (LERS). Hong Kong: USD/HKD and Convertibility Undertaking (CU) The move to buy HKD/sell USD at the weak-side CU is as designed in the LERS mechanism and should not come as a surprise or trigger undue concerns. Nonetheless, this is the first time since May 2005 that the HKMA had to intervene to buy HKD/ sell USD. Over the past decade, HKMA s FX intervention activities had been mainly on the other side of the trade, i.e. buying USD/selling HKD to inject liquidity into the financial system due to capital inflows as a result of global central banks easing policy, which pushed the HKD towards the strong side of the CU. 1 I Page

2 HKMA: Aggregate Balance FX Transactions (Lagged by 1 Day) HKMA: Aggregate Balance FX Transactions As our strategists noted earlier (FX Strategy: USD/HKD Trades Up To The 7.85 Limit, 12 Apr 2018), the progressive weakening of the HKD over the past 15 months has been due to the widening interest rate spread between US money market rates (LIBOR) and Hong Kong money market rates (HIBOR), to the HKD s disadvantage. 1-Month Interbank Rates, Daily, (%) 2 I Page

3 3-Month Interbank Rates, Daily, (%) Progressive US Fed interest rate hikes have pushed up US money market rates since early 2017, although the equivalent HKD rates continue to stay soft. This widening of the rate differentials meant that the short HKD carry trade had worked very well in the past year. For instance, the 1-month spread widened from as low as 1bps in Jan 2017 to more than 100bps in favour of USD. One key factor why HKD money market rates have been staying soft despite HKMA moving in lock step to raise the Discount Window Base Rate along with the US Fed funds rate is the abundant interbank liquidity as a result of the large aggregate balance (i.e. the sum of balances in the clearing accounts maintained by licensed banks with the HKMA). US Federal Funds Target Rate and HKMA Discount Window Base Rate There was some narrowing of the Hibor-Libor interest rate spread towards end of 2017 after HKMA took steps to reduce the aggregate balance (via issuance of additional HKD80bn of Exchange Fund bills in early Aug and mid Sep 2017) to bring aggregate balance down to HKD180bn. However, the spread re-widened subsequently after the Exchange Fund bill sale given the large amount of domestic liquidity. Even after recent HKD purchases by the HKMA, the outstanding aggregate balance of HKD129bn remains at the highest in nearly a decade, i.e. since Mar In the near term, our strategists are of the view that HKMA has the option to issue additional Exchange Fund Bills to soak up liquidity on a temporary basis to dampen any excessive declines in Hibor and the HKMA will also need to intervene in currency market to cap USD/HKD at I Page

4 Hong Kong: Aggregate Balance, Closing Keeping HK Dollar s LERS Sound And Solid On a more fundamental note, the recent HKMA s HKD buying intervention operations show that the HK dollar s Linked Exchange Rate System (LERS) mechanism works as designed, and the system remains sound and solid. We continue to expect the HKD link system against the USD to remain for the foreseeable future, supported by the following three key factors: institutional arrangement, time tested history, and sound fundamentals. 1. It should be noted that the HKD LERS is a currency board arrangement. This is different from an ordinary pegged currency system like those of Swiss National Bank s EUR/CHF peg (Sep 2011-Jan 2015) and Bank Negara Malaysia s ringgit peg (Sep 1998-Jul 2005). These two episodes showed that the pegged systems could be abandoned as abruptly as they were established by the respective central banks. However in HK, the Financial Secretary is responsible for determining monetary policy objectives and the structure of the monetary system, while HKMA is responsible for the operation of the LERS. This delegation of responsibilities means that HKMA alone could not alter the fundamentals of the LERS (see Functions and responsibilities in public finance and monetary and financial affairs, HKMA). Under the currency board arrangement, there is an automatic interest rate adjustment mechanism as the monetary base expands (domestic interest rates fall as HKMA sells HKD) or contracts (domestic interest rates rise as HKMA buys HKD). 2. The LERS (and HK s economy in general) has been tested time and again since its launch on 17 Oct 1983 and has been proven resilient even in the worst of financial conditions. It went through the significant volatilities including the stock market crash in Hong Kong in 1987, the Gulf War in 1990, the Asian financial crisis of 1997/98, global financial crisis of 2008/09, and RMB central parity reform in Aug A currency board arrangement is a necessary but not sufficient condition for a linked system to function properly. The effectiveness of HKD LERS is well supported by a number of key characteristics of the HK economy and fundamentals, including the flexibility and responsiveness of its labour, property, and retail markets; strong and solvent banking system, prudent and discipline fiscal policy, and strong external balances and foreign exchange reserves backing the monetary base (It should be noted that both FX reserve coverage ratio as well as flow changes in reserves and monetary base matter in the operation of LERS). 4 I Page

5 Hong Kong, General Government Overall Balance (IMF estimate) Hong Kong, Treasury Statement, Fiscal Reserves (Provisional), HKD Hong Kong Current Account Balance (% of GDP) 5 I Page

6 Hong Kong: Foreign Currency Reserve Assets Hong Kong: Components of Monetary Base Hong Kong: FX Reserves Coverage 6 I Page

7 Hong Kong: Changes in Monetary Base and FX Reserves (in HKD terms) Other than the strong financial backing and support for the LERS, HK s economic fundamentals in the past year have been buoyed by ongoing global expansion and stable economic activities in China. HK s jobless rate has fallen to a 20-year low of 2.9% as a result, which in turn provided support for private consumption. Looking ahead to , HK s economic outlook remains positive, supported by an expansionary budget and external trade activities. Assuming no major disruption from the ongoing US-China trade tensions, we expect HK s economic growth pace to stay firm at 3.4% in 2018 and 3.3% in 2019, moderating slightly from 3.8% in Hong Kong: Real GDP y/y% change Rising Hibor Rates And Potential Impact This combination of institutional arrangement, time tested history, as well as strong fundamentals will keep the HKD LERS well anchored for the foreseeable future. Like in the past, questions will undoubtedly arise whether HK should move from its currency board arrangement to a free float system, to a currency basket peg system, or change its anchor currency from the USD to RMB. As the LERS has served Hong Kong well so far, status quo is likely to be the case for now. It is premature to consider RMB as the anchor currency, given the dominance of the USD in international trade and investment, and the fact that RMB is still an emerging market currency. In addition, the RMB is not yet freely convertible and exchanged in large quantities. The lack of depth, breadth and liquidity of the offshore RMB market for the Exchange Fund to hold assets to back the HKD is also another major deterrent for the RMB to be anchored to HKD. 7 I Page

8 Of more immediate concern is that our strategists do not expect full yield convergence with US rates nor is it desirable at this stage since it would require the HKMA to lean aggressively against the tide of capital flows. From the current level of 1.36% ( as at 20 April), we therefore see 3M Hibor ending 2018 at around 1.60% driven primarily by 2 more FED hikes this year as well as a modest compression in the Hibor vs. Libor spread. One important consideration for the HKMA in its pace of withdrawal of domestic liquidity (via FX intervention and/or issuance of Exchange Fund bills and notes) which is consistent with the tightening path of global and some Asian central banks is the potential impact on local asset prices, particularly for the property market. HK s residential prices have gained more than 3 times since the 2008 global financial crisis. Even with a general uptrend in interbank interest rates, the Prime loan rate remains unchanged at 5%. If the past correlation holds between these two interest rates, there is certainly pressure for the prime rate to edge higher this year. How fast and how much domestic interest rates rise, including the prime rate, would largely depend on the pace of HKMA s FX intervention and/or liquidity withdrawal. The impact on property market is therefore of concern to the authorities and financial market as a whole and will be the key risk as HKMA normalizes its balance sheet. Hong Kong, Residential Property Price Index And Prime Rate Interbank Rates, HIBOR, 1 Month, Fixing, Hong Kong, Bank Prime Loan Rates, Daily, (%) 8 I Page

9 As such, it is very likely that HKMA will lean towards guiding local rates higher in a gradual and controlled manner, as pointed out by our strategists (FX Strategy: USD/HKD Trades Up To The 7.85 Limit, 12 Apr 2018). As for USD/HKD, we expect it to spend the next few months at or near 7.85 due to the persistent yield gap, but the pair is likely to pull back moderately to 7.83 by the end HK: FX And Interest Rate Forecasts Indicator 21 Apr Q18F 3Q18F 4Q18F 1Q19F USD/HKD US Fed Funds target rate USD LIBOR 3M HKD Hibor 1M HKD Hibor 3M Source: Bloomberg; UOB Global Economics & Markets Research 9 I Page

10 Recent Publications 20 Apr Indonesia: BI Maintains Its Neutral Stance 19 Apr 布伦特原油价格能维持在 70 美元 / 桶上方吗? 19 Apr Indonesia: Minimal Impact From US-China Trade Tensions, But Wary About Asset Market Implications 18 Apr 中国 : 中国人民银行下调部分金融机构存款准备金率 18 Apr 中国 :2018 年第一季度经济增速符合预期 18 Apr Malaysia: Inflation Edges Lower To 1.3% In March 18 Apr Japan: March Records Bigger Trade Surplus As Imports Unexpectedly Declines 18 Apr China: PBoC Makes Targeted Reserve Requirement Ratio Cut 17 Apr China: 1Q18 Growth In Line With Expectation 17 Apr Commodities Strategy: Is Brent Crude Oil Price Sustainable Above USD 70/bbl? Disclaimer This publication is strictly for informational purposes only and shall not be transmitted, disclosed, copied or relied upon by any person for whatever purpose, and is also not intended for distribution to, or use by, any person in any country where such distribution or use would be contrary to its laws or regulations. This publication is not an offer, recommendation, solicitation or advice to buy or sell any investment product/securities/instruments. Nothing in this publication constitutes accounting, legal, regulatory, tax, financial or other advice. Please consult your own professional advisors about the suitability of any investment product/securities/ instruments for your investment objectives, financial situation and particular needs. The information contained in this publication is based on certain assumptions and analysis of publicly available information and reflects prevailing conditions as of the date of the publication. Any opinions, projections and other forward-looking statements regarding future events or performance of, including but not limited to, countries, markets or companies are not necessarily indicative of, and may differ from actual events or results. The views expressed within this publication are solely those of the author s and are independent of the actual trading positions of United Overseas Bank Limited, its subsidiaries, affiliates, directors, officers and employees ( UOB Group ). Views expressed reflect the author s judgment as at the date of this publication and are subject to change. UOB Group may have positions or other interests in, and may effect transactions in the securities/instruments mentioned in the publication. UOB Group may have also issued other reports, publications or documents expressing views which are different from those stated in this publication. Although every reasonable care has been taken to ensure the accuracy, completeness and objectivity of the information contained in this publication, UOB Group makes no representation or warranty, whether express or implied, as to its accuracy, completeness and objectivity and accept no responsibility or liability relating to any losses or damages howsoever suffered by any person arising from any reliance on the views expressed or information in this publication. 10 I P a g e