HKD rates face near-term upward pressure from both external and domestic factors, but we do not expect HIBORs or HKGB yields to surge.
Front-end HIBORs: The Fed's tightening path remains the key external driver for dollar-pegged HKD rates. 1M HIBOR has approached 3.00% ahead of the FOMC meeting, while 1Y HKD IRS has risen 25bps to 3.74% over the past week. HKMA also raised the base rate by 25bps to 4.25% this morning.
However, further upside should be limited if the Fed's tightening cycle remains gradual. The terminal rate FFR is expected to hit 4.50% by end of 2027, comparing to the peak of 5.50% in 2023-2024. We see slim chances for near-term HKMA intervention at the weak side of the band at this stage. Any potential USD weakness from fiscal worries could help to keep USD/HKD away from 7.85. Meanwhile, the 1Y HKD IRS–USD OIS spread has also tightened to around 70bps, which may be insufficient to compensate for the maximum 129bp spot move across the 7.75–7.85 trading band. This should limit the incentive for further HKD carry positioning at the margin. With the Aggregate Balance broadly stable, we therefore do not expect HIBORs to surge.
Cyclical domestic factors should also temper the upside. Slower economic momentum should weigh on credit demand, particularly as the property recovery loses momentum. Southbound Stock Connect flows have also moderated. A softer property and capital-market backdrop should reduce demand for HKD funding at the margin.
Long-end rates: Longer-dated HKD yields should face more persistent upward pressure amid fiscal spending from the Five-Year Plan. Infrastructure investment in the Northern Metropolis region could translate into gearing and a higher term premium. Government debt has already risen to a historically high level relative to GDP at 82.5% in 1Q26. HKD corporate bond issuance is also 78.9% YoY YTD, driven by quasi-governmental corporates.
That said, several factors could partly offset the upward pressure. First, an improvement in government revenue would slow the net borrowing. A larger corporate tax base, supported by the influx of foreign corporates, could provide some revenue upside. Second, a gradual shift towards RMB-denominated government borrowing could reduce the supply pressure on HKD bonds, as the government is planning to settle part of its expenses in RMB. Third, stronger mainland participation through Southbound Bond Connect could absorb the rising HKD bonds supply, particularly when HKGB yields offer a pickup over comparable onshore bonds.
For more detailed analysis on the Five-Year Plan, please refer to our macro report to be published today.
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