Federal Reserve unlikely to raise interest rates in June, leaving Hong Kong’s real estate market in a state of uncertainty

While Federal Reserve chair Janet Yellen appears to be optimistic about the United States economy, many economists believe that the Fed is highly unlikely to raise its benchmark interest rate during next week’s meeting.

Many who heard Yellen’s speech in Philadelphia last Monday feel that the central bank is not in any hurry to raise rates, especially after May’s disappointing payroll data which showed only 38,000 jobs were added last month, way below market expectations.

Nonetheless, some Fed officials had hinted in media reports there would be at least two rate rises by the end of this year, the first possibly in July. However, other economists and Fed watchers feel the central bank is not in any hurry to raise rates.

US interest rates have been kept between 0.25 per cent and 0.5 per cent since last December when the Fed raised the rate by 0.25 basis points from near-zero levels introduced during the global financial crisis. It was the first US interest rate increase in nearly a decade.

This “will they, won’t they” conundrum has raised the big question in Hong Kong of the impact any rate rise in the local real estate sector which is under pressure from falling prices.

Market players, including analysts and real estate agents, believe the impact from a possible rate rise on home prices may be modest. But some observers say uncertainty about when mortgage rates will actually edge up could prompt some Hong Kong buyers to stay on the sidelines.

The Hong Kong dollar is pegged to the US dollar, meaning that any rate hike in the US is usually followed by Hong Kong banks raising interest rates as well. However, when the Fed raised the rate in December, local banks did not follow suit as most lenders have abundant liquidity.

The raft of mortgage tightening measures launched by the Hong Kong Monetary Authority (HKMA), the city’s de facto central bank, and an abundant new housing supply have had their intended effects in property prices. Citywide home prices began to soften last September, according to the pricing index compiled by estate agent Centaline Property Agency.

“The impact of a rate hike will be more significant on the mass market because buyers are generally more sensitive to interest rates as they have a higher debt-to-income ratio,” says Alva To, senior managing director for Hong Kong at DTZ/Cushman & Wakefield, an international property consultant.

“That said, a rate hike is usually a sign of a vibrant economy. Market fundamentals are still strong. A rate hike is just one factor that affects home prices. Other factors such as unemployment and the scale of future [housing] supply are also significant.

“Considering the current economic trends, I believe the low-interest-rate environment will persist in the near future and so its impact on the market [will be] contained.”

Mark Hahn, general manager of sales (2) department at Henderson Land, says it remains uncertain as to when the Fed will lift rates again. Even if a rate rise comes, it will be small and subsequent increases, if any, will be gradual.

“And even if there is a rate rise later this year, borrowing costs will remain at historic lows [in the near term],” Hahn says.

At present, most new mortgage loans are priced with reference to the Hong Kong interbank offered rate (Hibor). According to HKMA, about 85 per cent of new mortgage loans approved in April were priced with reference to Hibor. Prime rate mortgages for the same month accounted for only 7.5 per cent.

Interest rates on Hibor-based mortgage plans are usually one month Hibor, plus 1.7 per cent. To mitigate the risk of a Hibor spike, the lending rate is usually capped at a discount to the prime rate.

For example, the borrowing cost of a typical Hibor-based mortgage plan is capped at about 3.1 per cent below the 5.25 per cent prime rate followed by most banks, according to mortgage brokers.

Shortly after the Fed raised interest rates last December, Hibor shot up to 0.34 per cent in February from 0.22 per cent in December. But it declined gradually in the ensuing months to as low as 0.21 per cent as of May, statistics from the HKMA showed.

“While Hong Kong’s interest rates track those of the US because of the dollar peg, some variances may occur at times due to local factors, such as banks’ liquidity and capital flows,” explains Raymond Yeung, a senior economist at Sydney-based ANZ.

For the time being, Hong Kong banks still have ample liquidity to cushion the immediate upward pressure on local interest rates even after the Fed raises rates, Yeung says.

“Say if the Fed tightens the benchmark rate by 25 basis points, Hibor may not go up by the same margin immediately. The increase may be spread over a longer time, with a few basis points each time.”

King Yip, managing director of Hong Kong Mortgage Corporation, believes it is unlikely the Fed will raise interest rates this month, especially when Britain is about to hold a referendum on whether to stay or leave the European Union.

In a recent speech, Yellen warned of the negative impact of Brexit on the US economy, saying that it was one factor that the Fed would consider when deciding whether to raise interest rates.

“Chances are that the Fed will wait until [after] the US presidential election in November this year,” Yip says, adding that it is inevitable that buyers will adopt a wait-and-see strategy for a while. Against a glut of new home supply, prices will remain under some pressure, according to Yip.

According to Land Registry figures, sales in May of previously owned homes contracted by 4 per cent from the previous month to 3,354.

Derek Chan, head of research at Ricacorp Properties, forecast secondary market sales volume will fall 15 per cent this month to as low as 2,800, which he believes is due to the wait-and-see sentiment and intense competition from developers releasing new homes onto the market.