Picking up the Hong Kong premium

Better known for its stock frenzies and as a China proxy, Hong Kong has quietly grown its bond market into a quality haven in Asia. And a window has now opened for investors who want a piece of the action.

Hong Kong’s humble bonds are blooming. Often overshadowed by the city’s larger stock market, the growth of Hong Kong’s bond market has expanded 60 per cent since 2015,1 growing faster than most of its large Asian counterparts last year.2 While it’s still smaller than regional rival Singapore and several less creditworthy Asian peers, this challenger bond market is showing momentum. A handful of companies have recently come back to Hong Kong to issue more bonds in private placements - right after closing refinancing deals in the public market - due to strong investor demand.
A driving force behind this demand, as this week’s Chart Room demonstrates, is the correlation that Hong Kong bonds have with US bonds. The Hong Kong dollar’s longstanding peg with the US dollar means the city’s policy rates - and bond yields - largely track the US (though scarcity of Hong Kong bonds means they’re slightly pricier, reflected inversely by lower yields). As the US Federal Reserve draws closer to easing policy, Hong Kong bonds are therefore expected to follow US bonds and rally.
But there’s now also a sweetener to the Hong Kong bond offer. When hedged into the US dollar, they’ve come with higher yields than US Treasuries in recent quarters - a relatively new anomaly. What’s changed?
The answer lies in the nuances of Hong Kong’s currency regime. In spite of the peg, monetary policy in Hong Kong has lagged the US throughout policy cycles (both tightening and easing). For example, banks are able to hold mortgage rates or deposit rates if they deem the US rate path unfavourable for their business. Suppressed Hong Kong rates have contributed to tightening interbank liquidity in the city as traders ditched Hong Kong for higher US rates, which has in turn been exacerbated by a lacklustre local stock market (meaning less demand for Hong Kong dollars). This means the compensation for hedging HKD into USD, which is supposed to reflect the two markets’ interest rate differentials, has increased, tipping the spread of Hong Kong 10-year yields - when hedged - over US Treasuries into premium territory.
Hong Kong has more to offer bond investors than the spread suggests. It’s one of just a few Asian markets outside of Japan that is rated AA and does not impose restrictions on capital flows. The government, which is the biggest borrower, is backed by huge reserves (almost 25 per cent of GDP).3 Even the periphery of the issuer base is filled with quality: large financial institutions and well-known local companies, such as MTR, the metro operator, and the Airport Authority.
For multi-asset investors, Hong Kong bonds’ low correlation with risk assets in Asia (high yield bonds and equities outside Japan) may support diversification in uncertain times. With the help of a little pick-up over US Treasuries, Hong Kong bonds may finally benefit from some deserved attention.
1. Bloomberg data as of April 2024, based on value of bonds outstanding.
2. P.14 of Asia Bond Monitor (March 2024) by the Asian Development Bank. Growth rate second only to mainland China.
3. As of financial year 2023-24, according to the Hong Kong government’s financial results.