20180423-大华银行-Macro_+_Rates_Strategy_10页_1mb

Macro + Rates Strategy Summary

Core Content

This document discusses the Linked Exchange Rate System (LERS) in Hong Kong and its implications for the USD/HKD exchange rate, interest rates, and financial markets. It highlights the HKMA's intervention to maintain the stability of the HKD and the economic fundamentals supporting the LERS. The analysis is based on the USD/HKD exchange rate reaching the weak-side of the Convertibility Undertaking (CU) and the interest rate differentials between the US and Hong Kong.

Main Points

• HKMA's Intervention: The HKMA intervened by buying HKD and selling USD when the HKD hit the weak-side of the CU at 7.85. This is in line with the LERS mechanism and not unexpected.

• LERS Stability: The LERS remains sound and solid, supported by:

  • Institutional Arrangement: A currency board system where the Financial Secretary sets monetary policy and the HKMA manages the LERS.
  • Time Tested History: The system has withstood major financial crises, including the 1987 stock market crash, the 1997/98 Asian financial crisis, and the 2008/09 global financial crisis.
  • Strong Domestic Fundamentals: A resilient banking system, prudent fiscal policy, and substantial foreign exchange reserves.

• Interest Rate Dynamics: The widening Hibor-Libor spread has led to a strong HKD carry trade, with the 1-month spread reaching over 100bps in favor of USD. The HKMA's intervention to buy HKD may lead to a gradual increase in domestic interest rates.

• Future Outlook: The HKMA is expected to:

  • Gradually raise local interest rates to align with the US Fed's tightening cycle.
  • Maintain the USD/HKD rate at or near 7.85 for the next few months, with a potential pullback to 7.83 by the end of 2018.

• Risks to Asset Markets: The gradual increase in domestic interest rates may have a negative impact on asset prices, particularly the property market, which has seen significant price increases since the 2008 crisis. The Prime Loan Rate is expected to rise, which could pressure property prices.

• Anchor Currency Considerations: The USD remains the anchor currency for the HKD, and there is no immediate plan to switch to the RMB. The RMB is not yet freely convertible and lacks sufficient liquidity and depth to serve as a viable anchor.

Key Information

• HKMA's FX Transactions: In the week of 12-18 April 2018, the HKMA bought more than HKD51 billion worth of HKD and sold USD, as the HKD approached the weak-side of the CU.

• Interest Rate Spread: The 1-month Hibor-Libor spread widened from 1bps in Jan 2017 to over 100bps in favor of USD, reflecting the carry trade benefits for investors.

• Aggregate Balance: The aggregate balance of HKD remains at a high level, around HKD129 billion, which is the highest in nearly a decade, indicating abundant liquidity in the system.

• Economic Fundamentals: Hong Kong's jobless rate has fallen to a 20-year low of 2.9%, supporting private consumption. The economic growth is expected to remain stable at 3.4% in 2018 and 3.3% in 2019, assuming no major disruption from US-China trade tensions.

• FX and Interest Rate Forecasts:

  • USD/HKD is expected to remain at or near 7.85 in 2018, with a possible pullback to 7.83 by the end of the year.
  • US Fed Funds Target Rate is projected to rise to 2.50% by 2019.
  • Hibor 1M is expected to increase to 1.70% by 2019.
  • Hibor 3M is forecasted to reach 1.95% by 2019.

Conclusion

The HKD LERS continues to function effectively, supported by institutional framework, historical resilience, and strong economic fundamentals. The HKMA is likely to gradually increase domestic interest rates to align with global trends, while maintaining the USD/HKD exchange rate at or near the 7.85 level. The property market and asset prices are expected to be impacted by this tightening cycle, and the RMB is not seen as a viable alternative anchor currency in the near term.