US FEDERAL RESERVE
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Hong Kong Monetary Authority (HKMA)

Hong Kong braces for first interest rate hike in a year

Should the Federal Reserve raise interest rates next week, as expected, watch for local banks to outperform while property and exporters struggle

PUBLISHED : Friday, 09 December, 2016, 7:33pm
UPDATED : Friday, 26 January, 2018, 4:14pm

Hong Kong’s struggling businesses and markets are bracing for an interest rate rise next week for the first time this year. Exporters and the property sector are set to lose out, while analysts believe that financial services firms will benefit.

“We expect banks and insurance companies to benefit as US Treasury yields rise. In the first instance, property might seem fine but as real interest rates rise, this sector would underperform quite sharply,” said Sean Darby global head of equity strategy at US investment bank Jefferies.

“Manufacturing companies might also lose their competitiveness as the US dollar rises,” he said.

With interest rates set to increase by just 0.25 percentage point however, much of the effect of this increase will be felt in markets, rather than upon businesses themselves. Nonetheless, with more rate rises expected to follow next year, how companies respond to this first increase will suggest which areas will do well next year, and which are facing more troubling times.

We expect banks and insurance companies to benefit as US Treasury yields rise.
Sean Darby global head of equity strategy at Jefferies

“Hong Kong businesses are already dealing with an environment of sluggish growth and low consumption, a rise in interest rates will only to add to their problems,” said Nicholas Kwan, director of research for Hong Kong’s Trade Development Council.

“However, an interest rate rise of 0.25 percentage points is not likely to have too much effect. If a company is in a position where such a small increase in its cost of borrowing will push it over the edge, then the company was hardly in a good position to begin with,” Kwan added.

Nor will a rate increase come as a surprise. Markets are already seeing a rate rise as a done deal, with the bond markets pricing in a near 100 per cent chance that the US federal reserve monetary policy committee will raise rates at the conclusion of its two-day meeting on Wednesday.

Last month, Federal Reserve Chairwoman Janet Yellen told the US Joint Economic committee that an interest rate hike could come relatively soon, depending on incoming data. Authorities later announced that US unemployment figures reached a nine-year-low in November, suggesting that a rate increase next week is looking near certain.

With the Hong Kong dollar pegged to the US dollar, if the Fed moves rates on Wednesday in the US, the HKMA will announce a new base rate in Hong Kong on Thursday morning.

The bigger question is how quickly further rate increases will follow. When rates rose last December, most analysts expected two or even three rate increases in 2016, though now right at the end of the year, we are waiting for the first one.

However, once again, analysts at JP Morgan, Goldman Sachs, and Aberdeen Asset Management among others are anticipating two or three further rate increases in 2017.

“Hong Kong’s interest rates will rise quite rapidly in the next few years, dragging on property and consumption growth,” said MK Tang, a strategist at Goldman Sachs.

Tang said that Goldman Sachs expect property prices to fall by 15 per cent in the next two years, and economic growth to remain soft at 1.8 per cent in 2017.

Nomura economist Young Sun Kwon was even more pessimistic, predicting that Hong Kong’s GDP growth will slow sharply to 0.5 per cent in 2016, “given the city’s vulnerability to weaker Chinese growth and higher US interest rates”.

Exporters are likely to be hit hard by rate increases, as interest rates move in line with the strength of a currency. Higher interest rates in Hong Kong and the US, mean a higher US and Hong Kong dollar.

Most other currencies across Asia, including the Chinese yuan, Indonesian rupiah and Malaysian Ringgit will fall against the Hong Kong dollar, making Hong Kong’s exports comparatively more expensive.

As the yuan weakens against the Hong Kong dollar, mainland tourists will need to reach deeper into their wallets as goods and services become comparatively more expensive.

“A strong Hong Kong dollar [alongside strong US dollar] would affect tourists’ purchasing power going forward,” said Adrienne Lui, Hong Kong economist at Citigroup.

Such concerns are predicated on a more sustained period of rate increases next year however, and will not necessarily become a problem after just one increase next week.

“Our view is that next week’s rate increase will not affect the residential property market that much because banks will be unlikely to raise their lending rates amid stiff competition,” said Denis Ma, head of research at property consultancy JLL.

“A rise in rates will certainly have an effect on property prices, but later on in the rate rising cycle,” Ma said.

However, amid the doom and gloom for Hong Kong’s economy, there are some sectors that are looking forward to a rate increase.

“Banks have been struggling with the low interest rate environment ever since the global financial crisis,” said Louis Tse, director at VC Brokerage. “Now rates are expected to go up we have seen bank shares in Hong Kong rise significantly in the last few days.”

“Any increase in interest rates will help the banks see better asset yields almost immediately,” wrote Morgan Stanley banking analyst Anil Agarwal in a report.

“The recent increase in interest rate expectations ... is likely to prove a significant tail wind [for HSBC] given the approximately US$400 billion of surplus deposits that HSBC currently holds across the group.”

The opportunity to gain better returns on these deposits because of higher interest rates is a reason why banks will benefit from a rate hike.

It’s not all good news for banks however.

“There’s no free lunch, a hike in US rates does have collateral impacts,” wrote Chirantan Barua, a banking analyst at Sandford C. Bernstein.

“As US rates went up at the end of last year, loan volumes across the system tanked. In fact HSBC had negative loan growth in Hong Kong in the first half of 2016 for the first time since the global financial crisis,” Barua said in the report.

A sustained slowdown in Hong Kong brings with it added risks for banks as well. For that reason, Barua and his team prefer Standard Chartered to HSBC.

“The fact that the bank has hardly grown its book and risk appetite in the past two years should result in risk outperformance if Hong Kong actually deteriorates as US base rates move higher,” Barua wrote.

Additional reporting by Laura He and Sarah Zheng

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