How to deal with the capital siphon effect of fed rate hike?
How to deal with the capital siphon effect of fed rate hike?The Federal Reserve has repeatedly called out that march is likely to be the beginning of an interest rate hike cycle.Once the US dollar enters the interest rate hike cycle, it will increase the capital outflow and liquidity squeeze pressure of emerging economies, and increase the risk of national or corporate debt default.How can we meet this challenge?In this regard, Yan Feng, member of the CPPCC National Committee and chairman of guotai Junan International, has something to say.Reporter: The last round of quantitative easing (QE) by the Federal Reserve lasted for seven years, from November 2008 to the end of 2015.This round of QE began at the beginning of the COVID-19 outbreak in early March 2020, less than two years ago.A lot of Fed officials have been talking about raising interest rates. Do you think they are just saying it, or are there reasons for it?Yim: Let’s look at the fundamentals of the US economy at this point.Arguably, the fundamentals of the US economy are healthier today than they were in 2013:When the Fed signaled the taper in June 2013, the U.S. economy was still experiencing high unemployment and low inflation, with unemployment and PCE (personal consumption expenditures price Index) rising 7.5 percent and 1.5 percent year-on-year, respectively.The unemployment rate was 3.9 per cent in January and PCE growth was 5.7 per cent in December.Persistently high us inflation, acute job shortages due to weak supply chains and rising job vacancies may suggest a faster pace of rate rises than in the previous round.Reporter: What pace do you and your research team think the U.S. dollar will take once it enters the rate hike cycle?Yan Feng: Let’s review the pace of the last round of interest rate hikes by the Federal Reserve. The fed raised interest rates once in 2015 and 2016, three times in 2017, and four times in 2018. Finally, the target range of the federal funds rate was 2.25%-2.50%.The U.S. unemployment rate stood at 3.9% to 4.7% in 2017 and 2018, roughly close to the Fed’s target range of full employment.We expect the Fed to hike three times in 2022, three times in 2023 and two times in 2024, each by 25bp (0.25%).But there is no shortage of uncertainty about exactly when to start raising rates.At the end of last year, for example, the federal reserve’s monetary policy meeting minutes, according to economic strength in the United States and under the background of rising inflation, the fed will be earlier than previously expected or more quickly raising interest rates, but about the time table, Powell is not clear, he says policy makers are still talking about the table manner, may take 2-4 policy meetings to make decisions.Will shrinking the balance sheet lead to panic?Reporter: In the last two rounds of QE, the Fed doubled its total assets.If you enter the “shrink balance sheet” period, what size of assets do you expect to be reduced?Yan Feng: In the last round of balance-sheet reduction, the assets of the Federal Reserve dropped from 4.5 trillion US dollars at the end of September 2017 to 3.9 trillion US dollars at the end of September 2019, a total reduction of about 0.6 trillion US dollars.The Fed’s total assets were about $8.8tn as of January, and are expected to be about $9tn if QE continues until the end of March.Assuming the same rate as the last round of QE tapering, and assuming a pace of $90 billion per month and a reduction to around 20% of US nominal GDP, we estimate that it will take 3-4 years for the reduction to start at the end of this year or early next year and continue until 2026.But given what the market will bear, it may not be $90 billion a month, and the Fed’s total assets as a percentage of GDP may be higher than 20 percent when it’s done. There’s a lot of uncertainty.Reporter: Hong Kong is not only an important economy with open capital and financial account in the world, but also the largest offshore financial market in China. What do you think will be the impact of this policy adjustment by the Federal Reserve on Hong Kong?Yan Feng: As a major central bank in the world, the Policy adjustment of the Federal Reserve will have an important impact on the global financial market.In general, an end to the fed’s asset purchases and to raise the federal funds rate, can cause spillover effect to other economies, mainly reflected in boosting us bond yields, driven by a stronger dollar, attract some capital from other economies back the United States, other economies pressure on liquidity, market financing costs, increasing national or corporate debt default risk,Stock and bond markets in other economies face downward pressure, exchange rates generally depreciate and the financial environment deteriorates.If history is any guide, adjustments in US policy lead to a stronger dollar and financial turmoil in some economies.The dollar’s strength from 1993 to 2001 triggered the Mexican financial crisis in 1995, the Southeast Asian financial crisis in 1997, the Brazilian financial crisis in 1999 and the Argentine debt crisis in 2000.Therefore, the Federal Reserve adjustment policy will have a negative impact on Hong Kong as a whole.However, judging from the Hong Kong capital market, the impact in the controllable range, although COVID – 19 outbreak in global outbreak in 2020, the world’s major central Banks open caused abnormality loose monetary policy, capital spillover into the rest of the world, but the Hong Kong stock market as a whole has not caused by abundant liquidity bubble, valuations are relatively low.As of January 14, the Hang Seng index in Hong Kong stood at 24,383.32 points, basically maintaining the pre-epidemic level.At 11.5 times p/E and 1.2 times P/P, the Hang Seng index is still below its historical average, judging that there is not enough impetus for capital outflow from the stock market.However, it is worth noting that the capital balance of the Hong Kong banking system is HK $367.512 billion, which is in the high range.In terms of Hong Kong dollar exchange rate, the current US dollar/Hong Kong dollar is in the range of 1:7.78, which is in a relatively strong position under Hong Kong’s linked exchange rate system.In the current round of monetary policy tightening by the Federal Reserve, the interest rate gap between Hong Kong and the US is likely to widen, and there is a risk of capital flowing into the US dollar. Hong Kong dollar may face downward pressure against the US dollar in the short term.However, in the process of exiting this round of easing policies, the Federal Reserve has sufficient communication with the market, and it will take a long time, and the Hong Kong Monetary Authority has the space to actively adjust the policy in terms of whether and how to follow up the interest rate hike. Therefore, it is unlikely that the “taper panic” will lead to significant capital outflow.Reporter: You are based in Hong Kong on a daily basis, and you have captured many of the details in time.I would like to hear your suggestions on Hong Kong’s response to the us monetary policy shift.Yan Feng: I have five suggestions.First, the stability and development of Hong Kong’s capital market depends on the mainland’s economic growth.In the face of the federal reserve to raise interest rates and global stagflation, we suggest that the central strengthen monetary policy and fiscal policy coordination, with the steady monetary policy, with loose fiscal policy according to the international market situation changes the rhythm timely implementation of the tax cuts, promote the private sector profitability and willing to invest, expand the effective investment, increase consumption, with good RCEP stabilize and expand exports,To enhance economic growth and capital returns, highlight the capital-friendly nature of the Chinese market while cracking down on monopolies, encouraging competition and guiding common prosperity, so as to enhance the attractiveness of Hong Kong and the mainland to international capital and offset the “siphon effect” with the “magnetic attraction effect”.Second, strictly control the epidemic in Hong Kong and ensure the normal operation of commodity trade between Hong Kong and the mainland.As the pandemic continues to disrupt global supply chains, the domestic economy has shown strong resilience and the trade surplus has maintained strong growth, which is conducive to attracting external capital inflows.As an important trade window connecting China with neighboring Asian countries, Europe, the United States and other overseas countries, we suggest That Hong Kong actively and strictly control the spread of the epidemic, minimize the impact of the epidemic on transit trade between Hong Kong and the mainland, resume quarantine free customs clearance as soon as possible, and ensure the stability of the economy and people’s livelihood.Third, advance gradual interest rate hikes to deal with the possible continued outflow of funds from foreign exchange reserves.The HKMA could try to move away from passively following the Fed in raising interest rates.On the premise that the US interest rate hike is expected to be fairly certain this year, a small and gradual rate hike will be adopted to keep the Hong Kong and US exchange rates close to a strong level.Such a move could reduce the drain on Hong Kong’s foreign exchange reserves, rather than intervening after waiting for U.S. interest rates to rise.At the same time, gradual and small interest rate increase can partially reduce the impact of the liquidity balance between banks on the market, stabilize exchange rate expectations and avoid significant fluctuations in the financial market.Fourth, strengthen market monitoring through co-ordination with the mainland’s central bank and regulators and seek help from the mainland if necessary to mitigate capital outflows.Due to the particularity of Hong Kong’s currency issuing mechanism, the money supply of Hong Kong Dollar has always been affected by the ECONOMIC cycle of the United States, and the monetary policy lacks the ability of counter-cyclical adjustment. At the same time, Hong Kong is repeatedly attacked by international speculators when the interest rate of the US dollar changes.We suggest that the HKMA strengthen policy communication with the mainland central bank and regulators to achieve coordinated macro policy steps.By using big data, fintech and other means, an effective risk identification and monitoring model is established to jointly control malicious short-selling arbitrage between markets.When there is an obvious outflow trend of market funds, we can appropriately seek help from the mainland to alleviate the outflow situation.In addition, we propose to explore opportunities for improvement in the connectivity trading mechanism and entry barriers, which may become an important way to replenish liquidity in the Hong Kong market.Fifth, continue to leverage the complementary role of the Guangdong-Hong Kong-Macao Greater Bay Area in resources and promote the adjustment and optimization of local economic structure.In the medium and long term, we suggest Hong Kong increase support for scientific and technological innovation, small and micro businesses and green development.Make use of the complementarity of capital, land, industry and human resources in the Guangdong-Hong Kong-Macao Greater Bay Area to explore the direction of local economic structure transformation. On the one hand, it can gradually reduce its dependence on finance, tourism and other services and broaden channels to attract external investment.On the other hand, it can improve the local employment situation and people’s livelihood, thus enhancing the supporting role of the real economy to the financial market.Cui Luping, Reporter of Our Newspaper, The People’s Political Consultative Conference (The 5th edition on February 08, 2022)