How will Standard & Poor's downgrade of the US sovereign rating affect Hong Kong? Emil Wolter (head of regional strategy, Asian equities, RBS) says the S&P downgrade is not overly important in that it is largely backwards-looking. But it is part of much broader trends. Firstly, the global economy is slowly rebalancing - capital flows and the goods trade are moving back towards equilibrium. But strong resistance to hard policy decisions is impeding progress. Secondly, economic activity is changing to favour emerging markets rather than developed ones. More importantly, many emerging markets are reaping the benefits of structural reforms. Conversely, 'due to bloated social security commitments and ageing demographics, as well as excess debt and stagnant incomes, living standards have begun dropping in the advanced world' and will likely continue that way for years, says Wolter. Thirdly, the US dollar's status as the world's reserve currency has started to unravel. While no one currency could take its place today, he says global economic leadership is becoming more diversified and currency markets are likely to reflect that over time. Reserve currencies have come and gone for centuries, yet the present situation is perilous since it is hard to see any one particular replacement and global growth is fragile, says Wolter. Observing that the US dollar has been sold off significantly, he questions the role played by US Treasury yields as the world benchmark for a risk-free rate. 'Slowly, but surely, Treasuries are losing their relevance, being replaced instead perhaps by a crosscurrent of fundamentally stronger, but admittedly smaller and less liquid, alternatives,' says Wolter. As this process plays out, the outcome has got to be a rise in the overall cost of capital. That can be seen as bullish for Asian equities. Although Hong Kong is pegged to the greenback and therefore could suffer according to the above analysis, the reality is that local monetary policy has significantly realigned to benefit from China, says Wolter. This is best illustrated by the fact that in just two years, yuan deposits have grown from 1 per cent to 9 per cent of the entire system. Ivan Leung (chief investment strategist, JP Morgan Private Bank, Asia) says US and European downgrades are symptoms of a wider problem. The issue is that policymakers around the world threw enormous resources against the great recession, successfully preventing a great depression, but now are dealing with the consequences - downgrades, debt burdens, deleveraging and disappointing growth. Leung does not believe the downgrade will meaningfully affect US Treasuries. The US fixed-income market is the biggest and most liquid, and the US dollar is still the world's reserve currency. Ironically, a rush towards low-risk assets has pushed Treasury prices higher. The downgrade is not the problem per se, but it does exacerbate negative sentiment, he says. Consumer and business confidence is fragile and may be seriously affected by recent euro-zone problems and the US debt ceiling and downgrade shocks. With so many governments adopting austerity policies, economic growth is dependent on private sector consumption and investment. 'We do not anticipate a US double dip, but certainly see a challenging soft patch,' Leung says. 'Ironically, the slowdown in developed countries and correction in commodity prices will help emerging countries resolve their overheating and inflation problems.' Hong Kong will continue to benefit from Chinese growth while maintaining a monetary policy that tracks the US. Interest rates will remain very low for a long time, says Leung. He quotes former US president Richard Nixon's treasury secretary John Connally, who four decades ago said the US dollar 'is our currency, but your problem'. Leung expects the US dollar (read the Hong Kong dollar) will remain weak in the longer term, and emerging market currencies, particularly the yuan and others in Asia, will be strong. Slow global growth will support fixed-income markets, with high-yield bonds offering attractive credit spreads and local emerging-market debt delivering high coupons with potential for currency upside. Leung has been cautious all year on stocks given the macro issues, but he does like quality high-dividend equities. Patrick Ho (head of equity research APAC, UBS Wealth Management Research) does not expect the downgrade to trigger a massive sell-off of US Treasuries and Asian bonds, as proven by recent market behaviour, and it therefore does not represent an acute systemic risk. The impact on Hong Kong banks, which have 12 per cent of their assets in US Treasuries or financial-sector bonds, should be limited. But the downgrade and renewed fears of an economic double-dip have triggered sharp falls in equity markets globally. The Hong Kong market is used to being more affected by global capital markets and export downturns. It has a large exposure to the financial sector, including banks and properties, and is vulnerable to economic downturns. But the upside for Hong Kong will be a third round of quantitative easing by the Federal Reserve. Any increase in US liquidity will also be seen in Hong Kong, thanks to the dollar peg. This should raise asset prices in Hong Kong. Given the minimal foreign risk, thanks to the US dollar peg, investors could invest in Hong Kong for higher returns in Chinese stocks, Hong Kong properties or yuan bonds.