Some thoughts on how #HongKong financial markets could react in the coming weeks following the massive sell-off on Friday after the news that #China will impose national security law in HK.
1/23

The news caused a big decline in #HongKong stocks and the HK dollar on much bigger volume than usual.
2/23

The Hang Seng Index plunged 1,350 points or 5.6%. The broader MSCI #HongKong Index fared even worse, crashing almost 7%. Property developers led the declines with the Hang Seng Properties Index tumbling almost 8%.
3/23

The #HongKong dollar weakened to trade 0.06% lower at 7.7574 against the USD, its biggest single day loss in 6 weeks. HKD forwards hit a record high on Friday suggesting that weakness in the local dollar will continue.
4/23

12-month HKD forwards soared by a record 300bps, showing a demand for USD. A rise in forwards suggests the HKD could weaken to the bottom end of its trading band.
5/23

Volumes in USDHKD options surged to double their normal levels last week with options with a strike of 7.85 attracting huge volume, suggesting a surge in bets the HKD will weaken.
6/23

However bear in mind that the HKD is protected by a very large differential between interest rates in the #US and #HongKong. To a certain extent this will help support the HKD.
7/23

In addition the HKMA has massive firepower to defend the HKD. So while I would expect the HKD to move into the bottom end of its trading band I don't expect the peg to break. But I do expect large volatility.
8/23

So attention will turn to #HongKong stocks where the outlook depends on how the US responds and what #China does next. The HK government is totally impotent. There is nothing it can do to influence the sentiment of investors.
9/23

The @realDonaldTrump Administration will try to find a way to punish #China without damaging #HongKong. That's a very difficult tightrope to walk.
10/23

I expect #US secretary of State @SecPompeo will refuse to certify that #HongKong remains suitably autonomous from #China, a prerequisite for extending the city’s preferential #US trading and investment privileges.
11/23

However, will that lead to the US# revoking #HongKong's special trade, economic and customs privileges? If it did that would cause huge capital outflows and a collapse in HK's financial markets.
12/23

However, I think on balance the #US won't go that far. To do so would be highly damaging to #HongKong. That would also harm the US as well. But the US has a number of other options.
13/23

It could sanction individuals or businesses that it accuses of suppressing democracy in #HongKong. In particular it could put pressure on #US banks to cease funding such businesses.
14/23

The #US could also extend its threat of interrupting financial flows to #China to include #HongKong. It could order government pension funds to sell HK equities. Investment funds could be put under pressure to follow suit.
15/23

What is clear is that #China's move is very bad for #HongKong's economy and its financial markets, despite Beijing's efforts to emphasise that these are political moves that have no effect on the economy.
16/23

It's also clear that this increases uncertainty about the future of #HongKong and investors hate uncertainty, which translates into higher volatility. Whatever happens expect a wild ride for HK stocks in the coming weeks.
17/23

What could happen to calm markets? Remember there is nothing the #HongKong government can do. Any statement from Carrie Lam's administration is meaningless. It's up to Beijing & Washington. HK is caught in the middle.
18/23

Don't expect #China to back down. However, Beijing could calm volatility by saying that it will allow #HongKong to craft its own version of national security law, which would be different from China's version.
19/23

The #US could calm things by signalling that it doesn't want to damage HK. #China said at the NPC that it wants to implement the Phase 1 trade deal. The agreement is important to Trump and could persuade him to step back.
20/23

However, at this stage these are all unknowns. The American Chamber of Commerce in #HongKong says the threatened new laws could jeopardise business prospects in HK. But its too early to know if that's true.
21/23

While some will say #HongKong's status as an international financial centre is threatened, what will take its place as a gateway for capital flows into and out of China? Singapore is hardly a model of democracy itself.
22/23

However, this move by Beijing has increased the risks for #HongKong significantly. Some international investors may well say that the risk of holding HKD assets is now too big. In which case Friday's moves are just the beginning.
23/23