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.
The news caused a big decline in #HongKong stocks and the HK dollar on much bigger volume than usual.
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%.
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.
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.
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.
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.
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.
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.
The @realDonaldTrump Administration will try to find a way to punish #China without damaging #HongKong. That's a very difficult tightrope to walk.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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