We believe that differing monetary policy regimes and index constituents will dictate a separation between the Hang Seng Index and the CSI 300 into year-end.
Not only are Hong Kong Interbank Offered Rate (HIBOR) and Shanghai Interbank Offered Rate (SHIBOR) diverging, but real interest rates are moving north in Hong Kong and south in China. The two monetary paths are separating and so will the two indices.
Firstly, Hong Kong, like the United States, is dealing with an upward shift in the yield curve. Meanwhile, China has finally crushed SHIBOR to the floor while keeping the yield curve respectable.
Moreover, the People’s Bank of China (PBoC) retains a lot of independence in keeping rates loose as it deleverages. Although it has used medium lending facilities (MLFs) to ease financial conditions when these have matured recently, this has coincided with the reserve requirement ratio (RRR) being cut.
Secondly, Hong Kong’s real interest rates are not only diverging from that the US but also versus that of China. The Hang Seng Index is much more “financial asset heavy” with a high weighting of banks and property than its CSI counterpart.
Thirdly, the CSI 300 cash flow is surging and this means that the overall CSI 300 index continues to get cheaper versus Chinese government bond yields.
We have always felt that the PBoC would ease between 200 and 250 basis points over 2018 in order to backstop the banking system. Given that the PBoC has been issuing MLFs to provide longer-duration financing for the banks rather than the seven-day repo rates, as these MLFs mature they would naturally tighten policy.
Hence the RRR is used to counteract this natural tightening. The current RRR for major banks stands at 14.5 percent. This would put pressure on the Chinese renminbi to weaken. Given that the PBoC is easing faster and more aggressively each time while rates remain unchanged, this should force the RMB to slide through 7 to the US dollar.
Last week’s shifts in the US yield curve will force Hong Kong’s monetary policy to tighten further. After a brief respite, the HK dollar is returning to the weak side of the band. The fact that the US dollar 30-year treasury broke out from its range suggests that Hong Kong equity investors need to be less complacent over the direction of Hong Kong rates.
The Federal Reserve is expected to raise rates in December and three more hikes in 2019 alone. This ultimately will force HIBOR over the London Interbank Offered Rate. Unfortunately, this will leave Hong Kong real rates high relative to China. Moreover, we would expect any weakness in the Chinese currency to put a further risk premium on the Hong Kong dollar peg.
The bottom line is that Hong Kong and China equity markets appear likely to separate in local currency terms. China has more room to loosen policy while Hong Kong will likely continue to follow the Fed’s tightening path.
– Contact us at [email protected]