Hong Kong's currency and money markets have been rattled by the global turmoil as well as the special administrative region's economic ties to China. Now, the pain could spread to the island's property and banking sectors, according to a new analysis by Morgan Stanley.
As the Hong Kong dollar currently hovers near eight-year lows against the greenback and the Hong Kong Interbank Offered Rate (Hibor) nudges up, here's how the bank believes different markets will react:
Economics, foreign exchange and rates
While Morgan Stanley expects the Hong Kong dollar's 32-year-old peg to the greenback to be defended, there could be an adverse impact on growth, wages and inflation expectations. The economy is expected to decelerate to 2.1 per cent growth in 2016 from an estimated 2.4 per cent in 2015.
As long as the dollar keeps rising and the peg is in place, the Hong Kong dollar will also rise against rivals, blunting Hong Kong's competitiveness. Higher-cost products, coupled with slower growth, will pinch corporate profits, hurt investment, and lead to an adjustment in the labour market.
"If policy makers have to intervene in the currency markets to defend the peg, interest rates could remain elevated, weighing on asset prices and domestic demand," Morgan Stanley says.
Morgan Stanley notes that elsewhere, spikes in the rates at which banks say they'll borrow from each other have been associated with sharp declines in equities. Utilities tend to relatively fare better, while property stocks suffer. Tthe longer money market rates stay up and greater the extent of the increase, the more likely that stocks will stay under the cosh.
Morgan Stanley's year-end bear-case target for the Hang Seng index is currently 16,500 compared with the index's current level of 18,965.06.
The one crumb of comfort: stock valuations are already pretty low by historic metrics. The Hang Seng's trailing price-to-earnings ratio is now at 7.7, just a shade above the low of 7.4 reached during the Asian Financial Crisis.
The combination of the money market rate spike and doubts over the peg's longevity have damped sentiment for the property sector, despite supply falling short of demand.
"If Hibor remains high for a sustained level and pushes the prime rate to go higher, mortgage rates could go up, hurting affordability at a time when GDP and inflation have downside risk," Morgan Stanley says.
The investment bank is cutting the price target for Hong Kong property stocks by an average of 17 per cent.
Morgan Stanley reckons that if Hibor stays higher for longer, loan growth will be weaker than its 2 per cent expectation for the year.
Credit costs should climb and Morgan Stanley recommends sticking to banks with strong balance sheets. The top pick is Hang Sang Bank, while Morgan Stanley sees lenders with lower profitability and capital - Bank of East Asia and Standard Chartered in its coverage - will be at risk.