Low aggregate balances to gently lift Hibor
- Low aggregate balances will eventually lift Hibor
- But fears of a Hibor spike are overblown
- Short-term speculative flows matter
- Policies of the G3 economies also matter
The fall in the Hong Kong Monetary Authority’s (HKMA) aggregate balance to a post-GFC low has heightened expectations for Hibors to close the gap with their higher Libor counterparts. Having peaked at HKD426bn in 2015, the aggregate balance has since fallen below HKD60bn.
Empirically, there has been no correlation between the 3M Hibor/Libor spread with banking system liquidity since 2015. In fact, the 3M Hibor/Libor spread has widened out and turned more negative since 2015. However, at some point, low aggregate balances will start to bite and put upward pressures on Hibor. Several factors suggest that the fears of an acute jump in Hibor have been overblown.
A sizable aggregate balance is a post-crisis phenomenon. Much like the G3 central banks’ balance sheets bloated by their quantitative easing measures. The near-zero aggregate balance in the decade leading up to the 2008/09 crisis should serve as a point of reference for what lies ahead. For a more incisive look, the pre-crisis period should be split into two episodes: 1) mid-2001 to 3Q 2003, and 2) mid-2005 to mid-2008.
The average aggregate balance stood at HKD0.6bn and HKD2.5bn in the first and second episode respectively. The 3M Hibor/Libor spread of the two periods (at 3bps and -77bps respectively) would be relevant.
Accordingly, it appears that aggregate balances will start to impact Hibor if they are low enough, and the hurdle may be < HKD1.0bn. Comparatively, even if the balance falls to HKD2.5bn, the Hibor/Libor spread can still be large. Clearly, there are other considerations that impact short-term HKD rates. For example, the (87.3) loan-to-deposit ratio of Hong Kong banks today has climbed past 2006-2007 levels towards those in 2001-2003.
The appropriate 3M Hibor/Libor spread has become a function of HKMA’s liquidity policy and policies of the major central banks. The Fed is poised to stop unwinding its balance sheet in September at a size of around USD3.5tn. The European Central Bank (ECB) and the Bank of Japan (BOJ) have shown no intention to shrink their balance sheets. Accordingly, the decline in HKMA’s aggregate balance should start to slow from a structural perspective. Moreover, the HKMA may, as witnessed from mid-2005 to mid-2008, become more tolerant of ample liquidity conditions and have more than enough leeway to release liquidity if needed. Notably, the amount of Exchange Fund Bills & Notes outstanding exceeds HKD1tn.
Two short-term forces are worth mentioning. Firstly, the sizable net northbound flows (N-bound buy - sell transaction volume) into China’s equity markets have tapered off. N-bound inflows reached a historical high in January-February on optimism for a US-China trade deal. However, these flows have dropped to close to zero on profit-taking (CSI is now at a one-year high). This could in turn weaken demand for CNY and hence diffuse upward pressures on Hibor.
Secondly, there will be impetus for the USD/HKD to drift higher (necessitating HKMA intervention) whenever the Hibor/Libor gap gets too wide. Judging from the recent episodes, a 3M spread of 100bps tends to spur these trades. The current spread is still wide (-82bps) but the implied forward curves (USD swap and HKD swap) have already factored in significant spread compression two years out (the implied spread stands at -20bps). There is some scope for the 3M Hibor to rise relative to the 3M Libor, but we think that the HKD swaps space may have already more than factored this in.
Against this backdrop, we are not convinced that it makes sense to pay HKD swaps vs USD swaps to bet on even more Hibor underperformance than what has been priced in. Hence, we also expect the Prime Rate to remain at the current level through 2019.
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