Since early March, the US Federal Reserve (Fed) has lowered its policy rates to near zero and announced several measures to inject liquidity into the financial markets. However, USD liquidity has remained tight, and USD interest rates, as well as those of the HKD’s, have trended upwards rather than downwards. One may wonder why.
In the past few weeks, the coronavirus has been spreading rapidly in the US and many European countries. This has brought a lot of economic activities to a stop and caused a sharp correction in financial markets. Investors’ risk-off sentiment has notably heightened and they have turned away from equity and many other asset markets. USD cash has become the risk-free asset of choice. Besides, many financial intermediaries also tend to hold more USD cash to meet possible withdrawal requests from clients, replenish the margin for their own investments, or simply for contingency purpose. Such an increase in demand for USD has tightened USD liquidity and lifted the USD funding cost in the interbank market, notwithstanding the Fed’s lower policy rates.
The strain in USD liquidity has also been a hot topic in the HKMA’s on-going dialogues with other central banks and financial institutions over the past few days. Major central banks including the Fed have already jointly rolled out several easing measures. But I think more time is needed for the effect of the lowered policy rates and other easing measures to be fully transmitted to the markets, and by then the situation should gradually improve.
Under the Linked Exchange Rate System, HKD interbank interest rates will be influenced by their USD counterparts. Therefore, the rising USD interbank interest rates have led to the relatively firm HKD interbank interest rates in the past few days. The HKD interbank interest rates are also driven by the demand for and supply of HKD funding, and the recent IPO activities and quarter-end effect have all increased such demand. Overall speaking, the HKD money market continues to operate smoothly, and interbank borrowing and lending activities remain normal. Take the 1-month interbank rate as an example, the current level of 1-2% is not too high. Meanwhile, the overnight rate stays at around 1% level, and usually softens in the afternoon when banks have a better grasp of the settlement and payment needs of the day.
Our banking system has ample capital and liquidity buffers. Banks also hold some HK$1 trillion of Exchange Fund Bills and Notes, which provide further strong liquidity backstop for the banking system. The HKMA’s liquidity facilities would also be able to support our banks as and when needed. We will continue to closely monitor the markets, and maintain Hong Kong’s currency stability in accordance with the Linked Exchange Rate System.
Deputy Chief Executive
Hong Kong Monetary Authority
19 March 2020