Both will be key to Hong Kong’s own fortunes in the year ahead with the local economy tied to China while the local currency is pegged to the US dollar, meaning the city’s interest rates have to shadow America’s.
And while the US is expected to continue raising rates, the world’s second largest economy is busy cutting theirs as China’s central government struggles to hit growth targets.
“Fears of a (China) hard landing persist in the market,” wrote economists at National Australia Bank. “(Chinese) interest rate cuts are likely in 2016 – reducing pressure on indebted firms – but the impact on savers could prove counter-productive to the transition towards a more consumption driven economy.”
In mid-December the Fed raised base rates for the first time in nearly 10 years, moving higher from a rate of zero to 0.25 per cent.
Under current Fed projections the market can expect four further rate increases in 2016, followed by another four rises the year after.
This may be overly optimistic given the economic outlook, say many analysts.
Rabobank senior US strategist Philip Marey predicts the Fed will only raise rates twice next year given the weak inflation outlook.
“There are several downside risks to the pace of the (US) economic recovery. First of all, the strength of the US dollar continues to be a major headwind for exporting firms. Secondly, the global economy continues to be weak. What’s more, the downside risks to the Chinese economy going forward may be underestimated by the (Fed),” Marey wrote.
That could be good news for China and Hong Kong as a slower uptick in US rates will help stabilise the financial markets just as China’s government tries to manage its stated goal to move towards a consumption led economy, manage a rise in bad bank debts, and curb wasteful spending and over capacity that has blighted the country’s manufacturing and production sectors.
The yuan is already widely tipped to weaken further in 2016 - Lombard Street Advisors argue it is around 15 per cent overvalued on a real trade-weighted basis - but as the interest rate outlook for the US and China diverges there is an increased risk of a currency shock similar to August when the yuan suddenly fell 5 per cent sending regional currencies and markets into a tail spin.
Reorient said in a report that into December, “the RMB failed to recover but slipped further vis-à-vis the USD at an even faster rate, suggesting that capital flight deteriorated further into the year end, implying that the Chinese money market probably faced another chunk of liquidity leakage.”
It added that USD/RMB 12-month forward contracts are now trading just shy of 6.80 to the dollar.
“The key question for China in 2016 could be whether the country can reconcile potentially conflicting imperatives on domestic and external financial stability,” said Andrew Colquhoun, Head of Asia-Pacific Sovereigns at Fitch Ratings.
“Even if the initial move in China’s own currency is small, it might set off a downward spiral as other countries seek to maintain competitiveness. Additional broad dollar strength would then increase nervousness in emerging markets... It might even be enough to temper the pace of interest rate increases in the US,” wrote Julian Jessop, chief economist at Capital Economics.
In Hong Kong, anything that slows the pace of future US rate hikes will be welcomed by the city’s homeowners and borrowers, with local house prices already forecast by property analysts to fall by double digit percentage points next year.
On the plus side lower rents will help tenants and could ease prices of key consumer goods.
By: Benjamin Robertson.
Review: Emerging Market Formulations & Research Unit, Flagship Records.
For The #FacebookTeam