Hong Kong Exchange Fund faces challenges in today’s post-quantitative easing era

11 January 2017   Category: News, Asia, Hong Kong, USA, United Kingdom   By Asia Asset Management

Despite achieving investment returns of HK$42.5 billion (US$5.48 billion) in 3Q2016, the Hong Kong Exchange Fund is cautious going into the New Year as short-term fluctuations resulting from “black swan” events could put a dampener on growth and investor sentiment.

Eddie Yue, deputy chief executive of the Hong Kong Monetary Authority (HKMA), cites the Brexit referendum in June and the US presidential election result as being among these black swan events; which caused an initial knee-jerk reaction amongst investors, and then went against market expectancies with the FTSE 100 and the S&P 500 rising. 

“Even if investors had a crystal ball and were able to foresee these black swan events, they might not have been able to predict that the market response would be another black swan,” notes Mr. Yue.

In the first three quarters of 2016, unstable global economic conditions prompted the US Federal Reserve to keep interest rates on hold, while various central banks chose to expand their quantitative easing (QE) programmes – leading to market expectations of continued liquidity support by various central banks. 

However, in contrast, the fourth quarter of 2016 saw a surge in bond yields and a drop in bond prices as interest rates in the US spiked and QE measures halted.

Mr. Yue says the sharp fall in the US Treasury yields over the past ten years has created major challenges for the Exchange Fund, with yields reaching as low as 1.5% in 2016, compared to 5.2% in June 2006.

“Considering that the Exchange Fund’s bond portfolio totalled some HK$2.8 trillion at the end of 2015, a rough estimation suggests that the three to four percentage point difference represents a reduction of almost HK$100 billion in interest income annually,” says Mr. Yue.

However, he adds that low returns and high volatility, coupled with the diminishing complementary effects of bonds and equities and a strong US dollar, will continue to be the dominant forces shaping the investment landscape in the foreseeable future.