BofA forecasts HIBOR to stay low, unlikely to return to 4%

Bank of America anticipates that the Hong Kong Interbank Offered Rate (HIBOR) is unlikely to return to 4%, despite a recent drop to 0.58%, due to the dynamics of the Linked Exchange Rate System (LERS) and a bearish US dollar environment. BofA argues that robust inflows into the Hong Kong Dollar (HKD) driven by positive momentum in Chinese equities and expectations of Federal Reserve cuts will limit USDHKD buying at 7.85, thus keeping HIBOR at lower levels compared to previous weak-side convertibility undertaking (CU) cycles.

Analysis

Bank of America (BofA) posits that the Hong Kong Interbank Offered Rate (HIBOR) is unlikely to return to the 4% level, despite client inquiries following its recent significant decline from 4% to 0.58% for the 1-month tenor. This assessment is rooted in the mechanics of the Linked Exchange Rate System (LERS), with BofA asserting that front-end HIBOR would only align with the US Secured Overnight Financing Rate (SOFR) if market conditions favored the Hong Kong Dollar (HKD) carry trade and a reduction in the aggregate balance. BofA distinguishes the current environment from previous weak-side convertibility undertaking (CU) cycles, where the Hong Kong Monetary Authority (HKMA) actively sold US dollars to defend the 7.85 peg. Key differentiating factors include a prevailing bearish outlook for the US dollar, market anticipation of Federal Reserve interest rate cuts, and robust capital inflows into the HKD, buoyed by positive momentum in Chinese equities. Consequently, BofA anticipates that HIBOR and the HKD carry trade will exhibit different dynamics compared to past weak-side CU scenarios. With global appetite for the USD carry trade currently subdued, BofA forecasts that market interest in purchasing USDHKD at the 7.85 level, which would trigger HKMA intervention, will be considerably more limited than in previous cycles characterized by a wide HIBOR-SOFR spread, leading to a projection of HIBOR remaining at lower levels for an extended period.

Key Decisions for Investors

• Investors should recalibrate expectations for a HIBOR rebound to 4%, considering BofA's analysis suggesting a prolonged period of lower rates.
• Evaluate the implications of sustained lower HIBOR on funding costs for HKD-denominated assets and the relative attractiveness of HKD-based carry trades.
• Closely monitor developments in Chinese equity markets and Federal Reserve monetary policy, as these are identified as key drivers influencing HKD inflows and, consequently, HIBOR levels.