In Brief
- The economic damage wrought by COVID-19 has further weakened Hong Kong’s economy. Fortunately, The Hong Kong Monetary Authority’s (HKMA) response to the crisis has evolved from being, initially, extremely tentative to being substantially more supportive in recent days, with significant implications to HKD interest rates.
- Despite the Federal Reserve cutting Fed Funds rate and the HKMA subsequently cutting its base rate, HIBOR yields spiked higher due to a combination of tight liquidity and credit market concerns. The HKMA’s latest plan to reduce the issuance size of Exchange Fund Bills and increase the Aggregate Balance should improve market liquidity, reduce volatility and trigger a reduction in HIBOR yields.
- We expect local liquidity conditions to ease, volatility to stabilize and HIBOR yields to decline over the coming months. The credit outlook for financial and corporate bond issuers remain uncertain, investors should strike a balance between generating yield and ensuring liquidity and the safety of counterparties.
Already buffeted by US-China trade tensions and anti-government protests, the economic damage wrought by the COVID-19 outbreak has further weakened Hong Kong’s economy. The city has recorded three quarters of negative GDP growth and recent economic indicators suggest additional weakness ahead. Yet, HKMA’s initial monetary policy responses were extremely timid. However, recent announcements are substantially more supportive – with significant implications for HKD interest rates and investors.
Precarious Economic Pillars:
Tourism and exports, two of Hong Kong’s four economic pillars, already witnessed significant upheaval in 2019. The COVID-19 induced global shutdown and worsening local virus outbreak have significantly aggravated the negative impacts on these sectors, while threatening the health of the remaining two pillars - financial and professional services.
Retail sales have declined by the largest amount since records began in 1980. Exports for the first two months of 2020 declined by 12%y/y while the Purchasing Managers Index (PMI) hit a record low in February and only improved slightly in March – the reading has remained in contraction territory for the past two years. Finally, unemployment increased for eight consecutive months, hitting a nine-year high.
Wavering Monetary Policy:
HKMA’s initial response to the economic crisis triggered by the COVID-19 outbreak was extremely tentative – merely encouraged the banks to lend to small and medium enterprises. In contrast, the government announced three fiscal support packages of increasing size, taking total government spending on cash payments, wage support and business support to an immense HKD287.5bn, equivalent to 10% of GDP and similar in size to US and Singapore’s support measures.
Fortunately, the surprise Federal Reserve (Fed) actions on March 4 and 15, cutting the base rate by 50bps and 100bps respectively to a cycle low of 0.00% - 0.25%, allowed the HKMA to act – cutting its base rate twice to a three-year low. Unfortunately, Hong Kong’s base rate calculation methodology combined with tight local monetary conditions, negated the benefits of the Fed’s rate cuts – with HIBOR yields spiked higher (Fig 1a), while the HIBOR-LIBOR spread hit a 21-year high (Fig 1b).
Attempting to ease monetary conditions and improve lending, the HKMA subsequently reduced the countercyclical capital buffer by 100bps to 1% and reduced the regulatory reserves requirement by 50%; increasing the lending capacity of commercial banks by ~HKD750bn and ~HKD200bn respectively. However, neither measure stemmed the steady upward trajectory of HIBOR (Fig 1).
FIGURE 1: DESPITE AGGRESSIVE FEDERAL RESERVE BASE RATE CUTS, HIBOR YIELDS HAVE MOVED HIGHER, WIDENING THE HIBOR/LIBOR SPREAD.
Source: Bloomberg, J.P. Morgan Asset Management; data as of April 2020
Most recently, on April 9, the HKMA announced it would “reduce the issuance size of Exchange Fund Bills (EFBs) in order to increase the overall Hong Kong dollar liquidity in the interbank market”.1 The reduction, totaling HKD20bn across the next four bill tenors, will change the composition of the monetary base (Fig 2). While this action will only marginally decrease the percentage in EFBs from 65% to 64%, the aggregate balance will jump by 37% from its 10-year low.
FIGURE 2: EXCHANGE FUND BILLS DOMINATE THE MONETARY BASE
Hong Kong Monetary Base (HKD bn)
Source: Bloomberg, J.P. Morgan Asset Management; data as at 14 April 2020
Most recently, on April 9, the HKMA announced it would “reduce the issuance size of Exchange Fund Bills (EFBs) in order to increase the overall Hong Kong dollar liquidity in the interbank market”.1 The reduction, totaling HKD20bn across the next four bill tenors, will change the composition of the monetary base. While this action will only marginally decrease the percentage in EFBs from 65% to 64%, the aggregate balance will jump by 37% from its 10-year low.
Money Market Rate Implications:
Although substantial HKMA foreign exchange reserves suggest the HKD peg remains safe, the COVID-19 outbreak has negatively impacted local market liquidity, increased interest rate volatility and triggered a rapid surge in HIBOR yields.
For HKD cash investors, the current market situation offers attractive investment opportunities to lock in longer tenor yields. The HKMA’s decision to reducing EFBs outstanding sends a strong monetary policy signal – and we expect local liquidity conditions to ease, volatility to stabilize and HIBOR yields to decline over the coming months.
Nevertheless, weak global economy has escalated the uncertain outlook for financial and corporate bond issuers and increased their probability of credit rating downgrades. Investors should balance the need for generating an attractive yield with a focus on liquidity and safety of counterparties.
After a tentative start, the latest, aggressive fiscal and monetary policy actions by the Hong Kong’s authorities highlight their growing awareness of the economic challenges created by the COVID -19 outbreak. While, the proactive policy measures announced are unlikely to prevent a deep recession in 2020, they should limit downside risks.
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