Thursday, June 02, 2011

HKD Peg: Unbreakable?

There, that's more like it. We had our fingers crossed as we waited for the ISM and were rather chuffed that it came out pretty much where our model had called it. Good Model, pat on the head and an extra bowl of electrons for you.

TMM have only one more thing to say on the matter. Only two things come out of ISM.... and that's Fears and QE3ers. And this doesn't look much like Fear to us, so that kinda narrows it down.

The QE3ers are certainly rampant this morning but, even though TMM are thinking this looks like a repeat of 2010, it probably won't (probably due to observation affecting the outcome). So we would demur from joining the QE3ers just yet. In fact we are more interested in cutting our long held long UST positions, even though Equities look as though they have more downside to go.

More on the QE3ers at some other point, but before we move on, we have recently observed this headline hit the wires (yes, really).


€400bn, perhaps? That woud be a very European solution to the bailout problem. We look forward to the Greek, Portuguese and Irish cucumber crisis payments.

And now for something completely different: the HKD peg.

While a seemingly obscure point, TMM have been watching some action in Asian fixed income markets that has them very amused. But first a few charts:

1) Loan to deposit ratio of HK banks, per the Hong Kong Monetary Authority and the Hong Kong property price index. As you can see, property prices are on a tear and if you look at a few major banks, HKD deposits are beating a retreat.

2) Yuan deposits in Hong Kong (yes, that is a long scale). This is where the deposits seem to be going in Hong Kong - punters in HK see the rise of the Yuan as utterly inevitable and see putting money on deposit in Yuan as the only sure thing around. Now, TMM will be first to say that this is beyond stupid - you have low caps of how much you can convert in a day (~$3k USD), there are plenty of better options for Asian FX carry out there (Indo govvies / Singapore REITs, HK REITs, etc) that do not have liquidity problems and which actually pay positive real rates. Nonetheless, punters are punters and when it comes to deposits in HK they are driving the bus.

3) HK mortgage rates... vs Yuan mortgage rates: Here it is clear that while HKD mortgage rates are rising due to this funding squeeze for banks it is nothing compared to that experienced on the mainland, where the rate hike cycle is truly underway.

So here are the two salient problems here:

HK Commercial Bank: you only make loans on HK property in HKD - unfortunately, your deposits are running away. So what do you do? Make loans in CNY, basically accepting that HK is going to creep towards a CNY peg? Beg and plead with the HKMA to arrange some currency swaps? Or just keep on ratcheting up mortgage rates as your funding runs away to cause rates to level peg with yuan rates? In the meantime, your funding still keeps walking out the door.

HKMA: You are worried about a bubble as real activity is in Yuan but you have a USD monetary policy due to the peg. Do you repeg? Or do you just pester your banks about their loan to value ratios and force them into stress tests without doing anything at all to solve the root of the problem? To date, the latter appears to be the HKMA's attitude.

The sensible answer is to repeg and basically follow CNY monetary policy for better or for worse, because, lets face it, the HKD peg is an anachronism from when HK was a light manufacturing hub that exported most of its products to the US and Europe. It is of course now a financial services hub that is leveraged beta on China and Chinese capital markets activity.

So what is the trade? There is of course the old HKDUSD cross which is one of the more asymmetric trades out there, sadly you pay for it on risk reversals. Another trade though might be Hong Kong banks as distinct from mainland Chinese banks. If HK banks were to become organizations that got deposits, made loans and generally operated in Yuan they would no doubt be as hitched to monetary policy on the mainland as Chinese State Owned Banks and be the recipients of those sweet, sweet 3% Net Interest Margins that Chinese bank analysts know and love. They would also, however, not be natural lenders into all the dumb infrastructure and business lending that Chinese bank analysts know and hate.

Now, TMM may be crazy but if you are making 3% NIMs, not lending to fundamentally uneconomic policy projects and are reasonably well run, you can expect to get a 2-2.5x Price to Book multiple much like higher quality Indonesian banks. As a thought exercise, TMM have seen what the valuation uplift could be for a few HK banks.

In the interim, TMM expect some choppiness in these names as the HKMA girds them for the big inevitable change, but the asset risk is manageable here: HK property may be a bubble but these guys lend to 60% LTV and do not have the type of stuff on balance sheet that Chinese banks do. Going long HK banks and short Chinese ones might not be a bad way to play the HK peg, not to mention a China credit blowup, if you get bored of waiting for what feels like forever for something to happen in the FX market.


Leftback said...

Agreed with your thoughts on Treasuries, Nemo.

Shorted the long end yesterday for the first time in a long time, currently ITM. Not at all sure that the deluge of weak US economic data is at an end, but we might see slightly stronger numbers ahead as the commodity spike eases, with the price of gasoline being especially important for US consumers, as noted frequently in this space.

Anonymous said...

Re HKD, who cares about the risky when 1Y ATMF vol is 1.2% and negative carry on a 1-year cash position is 20bp (plus 90bp absolute downside if spot ever traded to the 7.85 upper limit)? When they go its clearly a 20% move to a 1:1 CNY peg. Pretty much all of the preconditions are in place, from the long-term plan to the short-term build in economic and political pressure. The only mystery is why no-one takes the trouble to dig into this when there is a ton of published research out there that gives away the official thinking. Hell, the guy behind all the technical changes in the peg in recent years even set out a template for such a move a decade back: {}. Beware "hot and boring Friday afternoons in mid-summer."

Leftback said...

Here comes a little bit more downside in equities, with energy and financials leading the way. The market is pricing in a fairly dismal number for tomorrow. 10y and 30y auctions next week might curb broker-dealer enthusiasm for long bonds to some degree with very low yields and supply looming.

TulsaGuy said...

I have been reading this site on and off since early 2009 and have to say its one of the best macro sites out there for practical traders, and the standard has been maintained since the original MM.

I would say a few things about the HKD revaluation idea.

First, this new generation HKMA guys do not have the street cred of the 1997 crop to change policy/surprise markets without very delicate, slow and gradual signaling, and we all know beijing runs the show behind the scenes now in HK so I won't assume HKMA would independently pursue HK's interest aggressively lest it pisses off beijing.

Secondly, for you to enjoy the 3% NIM, the tit for tat is you DO make policy loans. And i know from anecdotal experience that loan officers in mainland chinese banks (oxymoron here), you know that ones that have the contacts to people who WOULD borrow at +300bps, wont join foreign banks because a bank like HSBC can't give em the commissions the local banks are giving them.

Third, if the view is actually bearish China and overvalued properties a la chanos then you dont really want a inconsistent leveraged play like being long HK banks.

If you want some kind of hedge to your short positions, in case China doesn't implode, I would maybe go long China Mobile with 4% div yield, stable subscriber base at 10x earnings and potential growth from mobile payments/shopping/3g services being rolled out.

Full disclosure, I am positioned for a global slowdown but am not long china mobile (yet)

Tradebot said...

Bang on about QE3 chances , Nemo. No repeat of 2010 as the inflation is picking up and expectations are shifting higher - sure the US eco data sux but still looking for 2% growth. In addition, the political barrage that Fed took after QE2 and election year in 2012 has made the chances of QE3 VERY VERY low.

I've bearish (and wrong!) on Tnotes, but at 3% or below the risk for a big downside move in yields is low vs reasonable retracement to 3.5% or above when data picks up a bit. it will be a choppy ride though!

Leftback said...

No problems in China. Here is a picture of some Chinese auditors carefully inspecting the books.

Planking in Taiwan

Come to think of it, planking will probably catch on in Greece and among Eurostriches, if it hasn't already.....

Polemic said...

Thanks all, I am surprised actually at the depth of your comments and interest on HK. Thought we were wandering off the normal interest path there.
USTs of course much more up the normal strasse. yield up on growth (or less slowdown) , or yield up on inflation ( with no growth), or yield up on dissing USA re credit function if QE3 is threatened as that will be a a QE too far. But still room for madness and yield knife drop if we hit panic on the way.

been a short week over here in the UK but feels like friday night already - and that's before we even get to tomorrows lottery nfp numbers.

NFP predictions folks? Perhaps we should run a TMM NFP sweepstake.

FX said...


Leftback said...

Very weak number. Follow through selling continues. This is where we find out whether there are any JBTFDers left, and whether 1295 is a strong support level. LB thinks we see a few players unload Treasuries ahead of supply next week.

Leftback said...

ISM Services also pretty weak, so that completes the collection of the weak for the week....

At least the US data has taken the spotlight away from Eurobolleaux™ for the time being..

Tradebot said...

uuh, low NFP! crappy number...

however the bonds dont seem to have sold off that much... i guess that is the trigger to go short then!

FX said...

Watching teh first hour on the floor from my screen tells me we've got'em mac,I know how 'frustrating' its been, I hear you bro :) just wait.

Leftback said...

Having been burned many times by the Friday afternoon safety trade, LB is sitting around until late waiting to fade today's move down in Treasury yields.