Investor confidence in Hong Kong is dwindling as the government loses its grip on an escalating outbreak of the Omicron variant of SARS-CoV-2.
Bearish bets against Hong Kong’s shares have climbed to records and the benchmark Hang Seng Index is near a two-year low. Residents are converting the local currency into China’s yuan at the fastest pace in more than a decade, while the Hong Kong dollar is moving toward the weak end of its trading band against the greenback.
Even the territory’s typically resilient property market is showing cracks, with a gauge of home prices falling to an 11-month low.
After enduring some of the world’s strictest quarantine regulations under Hong Kong’s “zero COVID” policy for almost two years, Hong Kong residents are facing one of the deadliest outbreaks. Over 225,000 infections have been recorded in the current wave, although Hong Kong University researchers estimate that the true count is about 1.7 million people — almost a quarter of the territory’s population.
“Nobody knows where the government is going,” Jefferies Group equity strategist Simon Powell said. “If you’re a Hong Kong trader or fund manager, you’ve had a shocker — the performance has been awful. Throw into the mix that you’re probably home-schooling and your family is scared of getting sent to a quarantine camp, and you might even be sick ... people are having a terrible time.”
Many have had enough. There were 43,689 net departures from Hong Kong in the past two weeks, the most since the start of the pandemic, government data showed.
In a bear case — where the COVID-19 outbreak peaks late in the second quarter — Bank of America Corp analysts estimate that 2 to 3 percent of Hong Kong’s population could depart each month.
There are signs that the growing stress on people and financial markets is worrying authorities. Hong Kong’s banking regulator told finance executives that it is lobbying the government to shorten quarantine for inbound travelers, people familiar with the matter said.
In a statement posted on Tuesday, the government suggested it would ensure that financial markets remain open during a potential lockdown.
Officials are planning to restrict the movement of residents for four days at the end of this month during a mass testing exercise, local news outlet HK01 said on Wednesday. Concern that the government would impose a lengthy lockdown imminently has prompted panic buying of everything from food to painkillers.
Despite two years of planning, the virulence of the outbreak has caught officials by surprise. The financial hub averaged eight deaths per 1 million people over the past 10 days, the most among advanced economies, according to Bloomberg calculations based on Johns Hopkins University data.
While most major Western countries are past the peak of their latest wave of infections, Hong Kong’s ratio is close to surpassing the nine deaths per 1 million that the US recorded at the peak of its Omicron wave in January. Sentiment among investors is deteriorating just as the US Federal Reserve is set to increase interest rates for the first time since 2018, forcing Hong Kong to follow due to its currency peg. That leads to an increase in the cost of mortgages in Hong Kong and puts pressure on home prices, which the Bank of America said could drop as much as 10 percent.
The Hang Seng Index this week dropped to its lowest level since March 2020. Bearish speculators are driving about 16 percent of activity in Hong Kong’s US$6 trillion equity market — the highest proportion on record — according to the 50-day moving average.
Short interest on the US-listed iShares MSCI Hong Kong exchange-traded fund has risen to 20 percent of shares outstanding, the highest in IHS Markit Ltd data going back to 2006.
Shares of Hong Kong Exchanges and Clearing Ltd — which has in the past few years become a proxy for market sentiment in the financial center — has fallen 14 percent in nine days, the longest losing streak since 2015.
The company last month said that profit dropped for a third straight quarter, with chairman Laura Cha (史美倫) saying restrictions on travel, interest rate hikes and uncertainty over the pandemic are posing challenges.
In money markets, one-month and three-month interbank rates have climbed to their highest levels since late 2020 as liquidity tightens. A gauge of expected swings in the Hong Kong dollar is near its highest in more than a year.
Analysts at BNP Paribas SA and the Bank of America last week said that the currency could near the weak end of its trading band with the greenback at 7.85.
A sustained weakening could prompt authorities to defend the currency’s peg, further mopping up liquidity and sending borrowing costs even higher. That would affect everything from mortgage rates to corporate funding.
Markets around the world have been roiled by Russia’s invasion of Ukraine, as well as the resulting sanctions and efforts to restrict Moscow’s access to funds. Global stocks lost more than US$7 trillion in 14 days, while the cost of converting currencies such as the euro and the yen hit the highest since the early days of the pandemic.
Inflows from onshore investors could help offset the impact of capital flight and support the Hong Kong dollar, BNP analysts led by Ju Wang wrote in a note on Tuesday. Its regulators are considering easing listing rules for some companies, which might accelerate the homecoming of Chinese tech firms from the US.
Mainland-based funds have snapped up more than US$1 billion worth of Hong Kong stocks in the past five days, exchange data showed. A similar phenomenon happened in the wake of the National Security Law in mid-2020, which propped up Hong Kong’s financial markets.
Being bearish on Hong Kong’s markets and economy is becoming consensus. The risk is that positioning turns so one-sided that investors get caught wrong-footed if Hong Kong’s outbreak ends earlier than expected, or if Beijing allows Hong Kong to abandon its “zero COVID” strategy.
There is little evidence that either scenario could come true any time soon. Hong Kong reported 117 deaths on Tuesday and 32,597 new cases, and the total could surpass 4,645 by the end of next month, the Hong Kong University report said.
Ending “zero COVID” would require approval from Beijing. Chinese President Xi Jinping (習近平) told local authorities last month that halting the outbreak is “a mission that overrides everything.”
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