The charge of complacency is not one that can be levelled against equity investors in Hong Kong. Since its peak on May 3, the Hang Seng Index has plunged more than 14 per cent , with over half of the decline occurring in the third quarter, the worst quarter for the gauge in four years. The Hang Seng is the only stock market among advanced economies to have slipped into the red for the year to date, and is expected to suffer its worst earnings recession since the 2008 financial crisis, data from Bloomberg shows. The triple whammy of an escalating trade war, China’s economic slowdown (the sharp fall in the yuan has hit the revenues of Hang Seng companies, two-thirds of whose sales come from the mainland) and the collapse of Hong Kong’s own economy has led to a sharp deterioration in sentiment. Still, there have been no signs of panic in the financial system as a whole since the mass anti-government protests erupted in early June. Hong Kong’s exchange rate peg to the US dollar, the world’s longest-running currency board, has held strong, backed by an enviably high level of foreign exchange reserves. Partly for this reason, there has been no major capital flight, with just a modest month-on-month decline in local currency deposits in August. Even in the city’s more vulnerable stock market, the Hang Seng is down only 4.2 per cent since the first mass protest was held on June 9. However, last Friday’s controversial decision by Chief Executive Carrie Lam Cheng Yuet-ngor’s administration to invoke the colonial era Emergency Regulations Ordinance to ban protesters from wearing face masks may mark a crucial turning point in market perceptions of Hong Kong. Why the new anti-mask legislation isn’t going to be enough While Asia’s leading financial centre has been on a slippery slope for some time, as the unrest has spiralled out of control, Lam’s introduction of emergency powers is a red rag to a bull in the current, deeply politicised, environment. The ordinance, akin to martial law, gives the government the right to introduce far more restrictive curbs, ranging from curfews to property seizures and censorship. Even in the eyes of those protesters who favour a less radical approach, the political Rubicon has been crossed , with the mask ban now seen as a prelude to a tougher crackdown. More worryingly for markets, the invocation of the ordinance has forced the government to deny rumours that it will use its new-found powers to impose capital controls amid fears that confidence in the domestic banking system is at risk, especially if more of the city’s ATMs – nearly a 10th of which have been damaged and no longer function properly, the Hong Kong Association of Banks said on Sunday – are vandalised. This is the kind of reassurance that often backfires in a financial crisis, mainly because it ends up making depositors and investors more nervous than they already were. Why it’s OK to be cowardly when predicting 10-year Treasury yields Hong Kong is not Argentina. A cursory glance at the latest credit rating assessments of Fitch Ratings and Moody’s, which lowered their respective ratings on the territory last month, shows how strong the city’s financial buffers are, exemplified by Hong Kong’s status as one of the world’s largest net external creditors. Yet these buffers are now eclipsed by an economy that has had the rug pulled out from under it – retail sales in August fell by a staggering 23 per cent year on year as tourist arrivals from the mainland plunged 42 per cent – and a political crisis that is proving to be the mother of all stress tests for Hong Kong’s markets. Until now, the negative domestic determinants of sentiment towards the territory have been offset by supportive external factors. While escalating trade tensions have put Hong Kong’s economy under significant strain, major central banks’ dovish responses – in particular the US Federal Reserve’s efforts to try to prevent the global downturn from taking hold in America – have relieved pressure on the city’s debt markets and currency. The inconvenient truth about monetary easing Since the mass protests began in early June, the yield on the benchmark 10-year US Treasury bond has fallen a further 75 basis points to come within striking distance of its all-time low. What is more, mounting fears over a potential global recession in the coming year (which intensified last week due to a raft of bleak economic data across the globe) have made it more difficult to disentangle the external determinants of sentiment towards Hong Kong from the city-specific ones. Concerns that the backlash against the government’s use of emergency powers marks a new, more treacherous, phase in the crisis make it more likely that the domestic drivers of markets will hold more sway in the coming days and weeks. Sentiment towards Hong Kong is approaching a dangerous tipping point beyond which investor confidence in Asia’s financial hub may be fatally undermined. Nicholas Spiro is a partner at Lauressa Advisory