Hong Kong increasingly at risk of downward adjustment

Getting closer to the tipping point.

It has been observed that Hong Kong is increasingly vulnerable to a downward adjustment.

According to a research note from UBS, however, it might not be headed for a meltdown 1997-style.

After years of loose monetary conditions, domestic prices have severely divorced from fundamentals. In particular, housing is more unaffordable now than it was back in 1997 the undisputed bubble year. Domestic leverage has surged and consistently made record high.

Tightening has also been noted as already underway, with zero nominal rates, coupled with the weak HKD and negative real interest rates having been the secular reflation forces in HK since late 2000s. But two of the three macro trends above have reversed course.

Here’s more from UBS

The HKD is passively strengthening, piggybacking the strong USD. Recent depreciation in the RMB, albeit modest, has trigged similar moves in the Asian currencies. This adds to the HKD strength and exacerbates the deflationary force facing the economy.

Inflation is easing in HK. This, plus the anticipated increase in nominal rates as the US Fed hike rates, suggests that positive real interest rates could return in 2016. The tightening of monetary conditions has already been underway since late 2014.