Analysis: Hong Kong’s cheap funding window narrows as banks feel cash crunch

A general view of the central financial district at sunset, in Hong Kong, China March 11, 2021. REUTERS/Tyrone Siu

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SHANGHAI/HONG KONG, Aug 4 (Reuters) – Investors who have exploited Hong Kong’s cheap interest rates all year to fund other trades globally are finding the window is closing as the Local cash flow conditions are tightening and city lenders are getting closer to increasing the cost of borrowing.

Cash has fled Hong Kong dollars this year as small depositors with big fund managers seek better yields, or “carries”, outside the Asian financial hub, where interest rates have been below benchmarks world.

The dearth of new listings on the stock exchange has also kept capital away after a few years of prosperity.

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The city’s de facto central bank has spent this year buying Hong Kong dollars and raising its benchmark repo rate at record speed, trying to stem the tide – reducing interbank system balances by more than half in the past three months.

The pressure has kept the Hong Kong dollar pinned at the weaker end of its trading band since May. Still, traders and market prices suggest it will soon begin to put pressure on banks, until they pass it on to borrowers and the economy.

“Indirectly, it will be game over,” said Patrick Law, head of FX Asia-Pacific and North Asia local markets at Bank of America.

“When everyone’s cash surplus gets smaller and smaller, everyone tries to build up a cushion, which means they have to pay more for it. The cost of bank funding will go up,” did he declare.

“So at some point they will want to restore their profit margin by increasing the lending rate.”

Interbank rates are already on the move, with Hong Kong’s benchmark one-month overnight interbank rate up nearly 60 basis points (bp) in three weeks. The spread over comparable US dollar rates in London narrowed to 106 basis points from a three-year high of over 140 basis points in July.

HKDFWD= futures pricing suggests the spread could tighten further in the coming months as Hong Kong rates catch up, while there is a small pause in US rises.

“Now that the spread has narrowed…carry-related capital outflows are likely to slow down,” said Wang Ju, head of Greater China FX and Rates Strategy at BNP Paribas.

“This is especially true, given that the market now thinks the Fed has reached the maximum hawkishness.”


Hong Kong has operated what it calls the pegged exchange rate system for nearly 40 years, pegging the local currency to the US dollar and moving the city’s base repo rate in parallel with the US Federal Reserve.

Carry opportunities open up whenever local market-set rates in Hong Kong differ from dollar rates, and this year’s outflows are a reversal of inflows, especially through 2020 when the pandemic saw US short-term rates close to zero in a hurry.

The speed and volume at which the Hong Kong Monetary Authority (HMKA) is buying local currency to defend the peg has reignited periodic and fruitless speculation that the exchange rate system is in danger of breaking down.

Most economists and market participants see it as the prevailing policy and no threat to the functioning of the markets, even if the resulting drop in liquidity has been precipitous.

Aggregate commercial bank reserve balances at the HKMA fell from HK$457.4 billion last September to HK$144.8 billion on Wednesday as the HKMA sucks liquidity from the system.

The overall balance, the main indicator of liquidity in the banking system, will decline to HK$129.293 billion on Aug. 5, a HKMA spokeswoman said Thursday.

Analysts said banks are under the most pressure, as they have so far kept their own core lending rates steady. Major lender HSBC kept its best rate at 5% in July. Read more

“The pressure is mounting, but it’s not fully reflected in prime rates, which is going to change everything again,” Natixis chief economist Gary Ng said, as it would ripple through the economy through businesses and investors. borrowers.

A deeper cash drought – should the overall balance fall below HK$100 billion – or another big Fed hike in November could be the trigger.

“A sudden hike seems unlikely… (but) we expect the 1-month Hong Kong dollar HIBOR to continue to climb and banks will likely raise the prime rate after the Fed meeting in September,” he said. Ken Cheung, Chief Asia FX Strategist. in Mizuho in Hong Kong.

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Reporting by Winni Zhou in Shanghai, Selena Li in Hong Kong and Tom Westbrook in Singapore Writing by Tom Westbrook Editing by Vidya Ranganathan and Kim Coghill

Our standards: The Thomson Reuters Trust Principles.

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