Headline making events more than sell newspapers, they affect local currency and have a knock on effect on the ordinary man on the street. Here’s how recent events in the US and China have affected the outlook of the Hong Kong dollar and impacted ordinary Hongkongers.
US and China Influence on HKD
First, it should be noted that the HKD was pegged to the British Pound in 1935, freely floating in 1972 and pegged to the United States Dollar (USD) since 1983. The Chinese Yuan was pegged to the USD in 1994, depegged from the USD in 2005, and pegged again to the USD to enhance stability in 2008.
More recently, the Yuan was depegged from the USD in August 2015 to prepare for its entry to the IMF basket of reserve currency. China was successful in getting the elite status of reserve currency for Yuan in December 2015.
The purpose of this brief history is to show the heavy influence of the USD on the HKD and to a lesser extent, the Yuan. In other words, the US Federal Reserve has great influence over the HKD. The other major influence on the HKD originates from China – both in terms of government policies and economic events.
HKD Weakness In January 2016 – Pulled By USD & Pushed By Chinese Capital Outflow
The influence of these twin forces was greatly felt in Hong Kong in January 2016. Two significant events happened during this period. First, the Fed had raised interest rates for the first time in nearly a decade on 17 December 2015. Second, the Chinese equity market plunged on weak economic data and the misguided use of circuit breakers in the first week of trading this year.
The Fed rate hike suggested a higher interest rate outlook which pulled in funds into the USD. Two weeks after the market absorbed this news, the Chinese equity market plunged striking fear into the hearts of a great many wealthy investors in China. Their response was immediate. They sold their HKD for safe currencies like the USD which caused the HKD to weaken drastically.The official peg range for the USD/HKD is from $7.75 to $7.85 and the outflows challenged the upper limit to reach $7.823 on 20 January 2016 as seen in the chart below.
It should be noted that this was the third major Chinese equity meltdown in 7 months. The first episode was in June 2015, followed by September 2015, which was prompted by weak economic data. So what made this third meltdown so significant for the HKD?
The root cause was the raising of interest rates in the previous month by the Fed,and the apparent instability after the equity market plunged for the third time in 7 months.
Changes in the Past 3 Months
A number of significant events had occurred in three months. The market had calmed down gradually and the HKD had returned to its floor of $7.75. Let us first look at the Fed as they provide the background for analyzing the effectiveness of Chinese policies.
1. Dovish Fed – Reduced Rate Hike Opportunities
The Fed struck a dovish note in its recent March 2016 meeting. They were cautious despite the moderate growth of the US economy. Their concern included weak oil prices and higher risk of international markets which included China. They were not sure if China could find their economic footing. After all, Moody’s had downgraded its ratings for China which is currently facing problems of high debt, slowing economy and risk of economic transition.
The Fed had cut its rate hike forecast from 4 to 2 this year and this dovishness is the first major turning point for the HKD. This would mean that Chinese funds are less attracted to USD and have lesser incentive to flow out.
2. Change In Chinese Regulator
After the first market plunge in June 2015, the Chinese authorities took a series of measures such as banning short sales, creating a national team of institutional buyers and delaying new IPOs. They promised that such a decline would not happen again, but it occurred again in September.
This prompted them to adopt circuit breakers, created initially for the commodities market, for the Chinese equity market in January 2016. Their good intention was to allow the market time to calm down by closing the market temporary. However, it backfired when Chinese investors realized that they weren’t able to sell and sold everything in panic once the market opened.
The Chairman of the China Securities Regulatory Commission (CSRC) is ultimately responsible for the orderly functioning of the market. After 3 major plunges, China finally replaced the incumbent Xiao Gang with Liu Shiyu on 21 February 2016. This improved market confidence in the stability of the Chinese market.
3. Gradual Strength In Chinese Market
The first bad market news to sink the Chinese equity market early this year was the shrinking manufacturing sector in December 2015. After contracting in January and February 2016, Chinese manufacturing finally grew slightly in March 2016. This coincided with the growing strength in the services sector.
This mild growth had eased concerns about the state of the Chinese economy as it transits from an export and investment oriented economy to one based on consumption. At least, there would be no replay of the January 2016 plunge in the next 3 months given the gradual recovery of the Chinese economy; provided that there are no new shocks.
Implications For Average Hong Kongers
All these events will imply these 3 outcomes for Hong Kongers:
1. Stable and strong HKD
2. Lower property price
3. Lower Chinese tourist arrivals
Lower Inflation & Better Tourist Advantage With Strong HKD
First, the Fed’s retreat and the gradual recovery of the Chinese economy means that the pressure for capital outflow would subside leading to a stable and strong HKD. Investors are adopting a wait and see approach before they regain exposure in equity.
For the average Hongkongers, they can take advantage of the stronger HKD when they convert their currencies for overseas travel. Inflation would also be lower with a strong and stable HKD. This would mean some relief from the high cost of living.
30% Lower Property Price in Hong Kong
Secondly, Chinese investors were not coming in droves to buy Hong Kong properties which forced developers to slash prices to move inventory. The increased housing supply also helped to improve housing affordability. A recent study placed Hong Kong at the top of least affordable cities globally where the median house cost 19 years of median income.
Chinese investors are still licking their wounds after three major market plunges. This is good news for the average Hongkongers as you can buy your houses cheaply. In the first week of April 2016, major developers such Wheelock Properties and Sun Hung Kai Properties (SHKP) were dangling significant discounts of 26.5% to attract buyers. Their margins are at the thinnest since the 2003 Sars crisis. This is good news for new home buyers but bad news for existing home owners. Overall home prices had fallen 13% off their peak in September 2015 and analysts expect prices to drop another 30% by the end of the year.
Lesser Mainland Tourists = Lower Cost of Living
Lastly, the average Hongkongers can expect to see less tourists arriving from Mainland China. The Chinese are saving up after losing money in three major market plunges. The heavy influx of tourist from Mainland China drove up prices of necessities like shampoo and milk powder and also luxury goods last year.
After foregoing their annual lunar new year trip, the general consensus is that the Chinese are unlikely to return in bulk this year. For the average Hongkongers, this means a lower cost of living as retailers cut prices in response to lower demand which caused retail sales to drop by 21% in February.
Thanks for reading
We know that major macroeconomic trends can be complicated and we aim to simplify them for your consumption, so you will know how major economic trends impact the lives of the average man on the street.
This article is written by freelance writer, Ong Kai Kiat, commissioned by 4xLabs. He has a keen interest in macroeconomics and technology topics. You can reach him at firstname.lastname@example.org. Please feel free to contact him if you have any queries about this article.
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