Alarm bells for Hong Kong

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Hong Kong is forced to raise interest rates at a time when its economic growth slows and its property markets are under pressure.
Hong Kong is forced to raise interest rates at a time when its economic growth slows and its property markets are under pressure.

Asset markets are in a state of siege, writes Matein Khalid

By Matein Khalid

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Published: Sun 31 Jan 2016, 11:00 PM

Last updated: Mon 1 Feb 2016, 4:36 PM

"One country, two systems." This was the historic formula under which Margaret Thatcher agreed to hand over the British Crown Colony of Hong Kong to the People's Republic of China, then ruled by Paramount Leader Deng Xiao Ping. The Hong Kong dollar's spike to 7.81, on the high end of its 7.75-7.85 band, demonstrates the sheer scale of the speculative attack against Asia's oldest currency peg. The chaos in Chinese financial markets has spilled over to Hong Kong due to the $500 billion-plus borrowed by Mainland financial institutions in the island's interbank market. This is the reason Bank of East Asia, a Hong Kong retail bank, has fallen 25 per cent in the past month. Even HSBC has fallen 20 per cent since August 2015. While the Hong Kong Monetary Authority has $350 billion in reserves to defend the peg, local interest rates will rise, a disaster for the most leveraged, overvalued property market in the Pacific Basin.
Like the GCC, Hong Kong is forced to raise interest rates at a time when its economic growth slows and its stock and property markets are under pressure. Economists call this "a suboptimal currency area" since the business cycle of the US and Hong Kong are no longer synchronised but the currency peg devastates the local stock and property markets. The Hang Seng index is highly correlated to the monetary liquidity in the Hong Kong interbank markets and inversely correlated to a spike in the Hong Kong Interbank Rate, or Hibor. This linkage is even more pronounced for Hong Kong property stocks, notably Sun Hung Kai Properties and Henderson Land, whose shares can well fall 20 per cent in 2016. The Dragon is wounded and its fire will gut the Hang Seng property index, just as China's crackdown on corruption destroyed the value case in Macau shares.
I find it alarming that the three-month Hibor has now risen above the three-month Libor for the first time since the 2008 global financial crisis. The three-month Hibor rate has nearly doubled in the past month due to speculative attacks on the Hong Kong dollar peg and the exodus of Chinese flight capital as Shanghai shares fell 22 per cent in January 2016 alone. The rates on the interbank market could rise by at least another 100 basis points in 2016. George Soros' bearishness on China, awful PMI numbers and a crisis of confidence in the ability of Chinese policy makers to manage a securities markets, the lifeblood of a capitalist economy. China's $28 trillion credit bubble, the biggest credit pyramid in human history, means a Japan-style lost decade for the People's Republic's $10.4 trillion economy. This means the world faces a 10-year bear market for Chinese equities, crude oil and the emerging markets, when the Morgan Stanley EM index could well fall another 25 per cent to 540. As capital flows accelerate from China, I expect the People's Bank to stun the world financial markets with a shock devaluation in the Year of the Monkey. This is the reason China H shares trade at six times earnings. This is the reason the Hang Seng index has fallen below 19,000. This is the reason the Bank of China, founded by Chairman Mao, trades at three times earnings. This is a financial Great Leap Backwards for the Communist Party.
Lord Rothschild advised to buy when "blood runs on the street". Asia-Pacific shares now trade at valuation bottoms last seen during the 2002 (Sars) and 2008 (Lehman) bottoms. As in the GCC, panic selling by offshore funds has crated deep value bargains even though Asia is a growth warrant on the global economy. Asia is also the epicentre of the shock waves from China's economic hard landing, forex and debt shocks. If the US economy slips into recession, all bets are off in Asia. The world faces history's first "Made in China" global recession, as I argued so often in this column in the past year.
This year is a US presidential year that could well see Donald Trump move into the White House, the Chinese yuan devalue by 15 per cent and Brent crude fall to $20 a barrel. A world in which the Saudi Tadawul, Shanghai A shares and Wall Street money centre banks fall 20-24 per cent in a month is a world begging the Federal Reserve to reconsider its planned four rate hikes in 2016. The world desperately needs a rate cut but the Yellen Fed is a central banking Nero, fiddling while Rome burns. In such a world, as Madonna's Material Girl once observed, the guy with the cold hard cash is always Mr Right!
Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at: matein@emirates.net.ae


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