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Economic Update

2016/11/30

The Recalibration of Interest Rates in the U.S.

Uncertainty has remained high in the post-U.S. election era, both in Hong Kong and abroad. At the same time, with the stable job market performance in the US, it is becoming clearer that interest rates will be moving upwards in the near term and onwards. Let’s look at how Hong Kong might be affected.

Outlook of the U.S. economy

In recent months, the U.S. economy has been making continuous progress toward the objectives of achieving price stability and maximising employment. Inflation is picking up moderately in 2016, partly due to the increase in rental expenses (see Chart 1). At the same time, the slight uptick in gasoline prices led to a rise in costs related to transportation, which saw year-on-year (YoY) growth for the first time in October after 26 months of continuous decline.

The job market’s performance makes a strong case for the stabilisation of the U.S. economy (see Chart 2). On a monthly basis, new job growth averaged 180,600 per month during the first ten months of 2016. This is lower than the average of 228,700 in 2015, but still far above the average of 141,400 between 2003 and 2006 – a period when the economy was growing more rapidly. At the same time, the unemployment rate stood at 4.9% as of the end of October, maintaining a steady level seen during the year. During the first ten months of 2016, the monthly income of American private sector workers also improved, recording a 2.1% YoY growth. The stable unemployment rate, the new job creation level, and the steady income growth suggest that the U.S. economy continues to show signs of sustained recovery.

Against this backdrop, there will be stronger justification in calling for Fed rate hikes. In the FOMC meeting in September, it was projected that the Fed Fund Rate would be revised upwards by 25 basis points (bps) this year, while it would likely go up by another 50 bps in 2017. The post-election development in the market seems to confirm that this expectation will remain intact.
There is an ongoing repricing of the inflation, cost of borrowing, and growth outlooks in the post-election era. For instance, studying the U.S. Treasury yield curve, it can be observed that the higher interest rate environment is being factored in (see Chart 3). At this point, we maintain our view that interest rates would be brought up by one notch in December. Looking ahead, should the current macroeconomic conditions remain intact, the Fed will likely raise rates twice in 2017.


 

The impact on Hong Kong

Due to the peg of the Hong Kong Dollar (HKD) to the USD, the different patterns of the Fed’s and the other major central banks’ (e.g. European Central Bank, Bank of Japan) interest rate policies could lead to a stronger HKD.

A stronger HKD will lead to lower imported inflation, as our city imports an overwhelmingly large percentage of locally consumed goods. This should allow the city to fend off some early signs of rising food price-driven inflationary pressure transmitted from the Mainland. All other things being equal, a low inflation environment would ease the downward pressure on consumption, which is especially important when salary growth is projected to be moderate as reflected in different studies in the city.


 

On the other hand, the negative impact of the strong USD would provide another blow to the tourism sector. In an earlier article, we explained that Hong Kong is losing its popularity with Mainland Chinese visitors to other Asian economies. The strength of the currency would further dent our competitiveness (see here).

All in all, recent developments suggest that the cost of borrowing will probably increase in the near term, even though we do anticipate that Hong Kong will not follow the highly-anticipated 25-basis-point hike in December (see here). Nevertheless, it is a matter of when, not if, this impact will be felt. Given the indication of the steepening yield curve, the tempo of interest rate hikes will become faster and overall borrowing costs in Hong Kong will pick up in 2017.


The Hong Kong Institute of Human Resource Management (see here), The Hong Kong People Management Association (see here), and Willis Towers Watson (see here)


 

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