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Demonstrations and HKD Rally
Demonstrations in Hong Kong over the extradition bill might be overshadowed by activity in the local FX market. Hong Kong dollar has risen to its strongest level against the USD in today trading at HIBOR has surged. HKD remains the regions most overvalued currency despite indications of economic vulnerabilities. Weakness in US rates on changing Fed expectations and improvement in Hong Kong (1-month HIBOR 2.42% from 0.92% in February) has narrowed LIBOR-HIBOR spread. Yet fears of de-pegging from the USD are overdone. The Hong Kong Monetary Authority’s (HKMA) has over $400bn of reserves which to defend the currency. Despite negative impulse from the Chinese economy, including trade tensions, we do not anticipate a break in USDHKD or changes in the current FX regime. Despite social unrest, the stability of the Hong Kong banking system, lack of FX alternatives and HKMA’s firepower suggest that policy makers maintain the ability to manage upward pressure on interest rates. In the midterm, USDHKD should reverse to retest the 7.850 weak-side convertibility. In the near, term there is concern over the contraction of HKD liquidity. Banks have lent heavily to local real-estate developers and mainland banks. Combined with the new appetite from speculators (due to PBoC issuing bills in HKD) might constrict HKD availability.
Market pauses ahead of US CPI data
After rallying to a monthly high on Tuesday, equity markets consolidated on Wednesday. Front month futures on the S&P 500 stabilised above the 2,880 points, down 0.23% on the session, while in the Europe EuroSTOXX 50 futures edged down 0.29% to 3,391 points. It is worth noting that the Swiss Market Index (SMI) reached an all-time high yesterday as it hit 9,871.44. Thanks to the solid performances from Nestlé, Novartis and Roche who helped to lift the index by 437, 310 and 230 points, respectively, since the beginning of the year. If one man should be thanked for the last rally it is the ECB President. Indeed, Mario Draghi took a dovish turn at the last meeting, as it left the door wide open for further monetary easing. Indeed, the governing council discussed the possibility of restarting QE and cutting rates.
Recently, the Federal Reserve has also turn to the dovish side and showed concerns about the economic growth and the negative effects of the ongoing trade war. According to the OIS market, investors are now pricing at least two rate cuts before the end of the year. In our opinion, this prediction is a bit too adventurous, as we believe the Fed will use its last bullet cautiously.
Today, all eyes are on the inflation that are due for release at GMT 12:30. Headline inflation is expected to have eased to 1.9%y/y in May, while the Fed’s favourite gauge of inflation, the core measure, should print flat at 2.1%y/y. Both the equity and bond markets are pricing a rate cut in the near future, meaning that the risk is skewed to the upside on today inflation report. Indeed, higher inflation readings could trigger a sell-off, as market participants would discount a dovish move from the Fed in the near term. On the other hand, significantly weaker inflation readings, especially for the core measure, would fuel the current rally. Overall, even though we believe the market is misreading the Fed intentions by anticipating several rate cuts in the near future, we believe that the Fed would ease further monetary conditions in the second part of the summer at the earliest.