The SARS playbook; HK's credit rating downgrade

We look at how the markets react through the SARS episode. We expect limited impact from HK’s credit rating downgrade.
Eugene Leow, Wei Liang22 Jan 2020
    Photo credit: AFP Photo

    Rates: The SARS playbook

    The rapid run-up in asset prices since the start of year rendered the market vulnerable to a pullback. That finally came when worries over the Wuhan virus came to the fore with a confirmed case in the US. To be sure, the reaction is still muted with the S&P 500 just 8 pts off its Friday close (a record high) and the VIX is still below 13. Bond traders were more wary, driving 10Y US Treasury yields below 1.80%. Overall, it was the Hang Seng Index that took the hardest hit (down 2.8% yesterday). The news flow on the virus spread could get worse over the coming few weeks as intra-China travels pickup in the Lunar New Year period.

    While details on the corona virus are scant (unknown fatality rate), we reckon that the SARS period (November 2002 to July 2003) could offer some clues as to how markets could pan out. In the two charts covering 10Y yields and stocks indices across China, Hong Kong, Singapore and the US, the trends are clear. Yields and stock prices fell in the first few months of the SARs outbreak and rebounded thereafter. We suspect that investors could rein in their risk appetite somewhat, keeping US yields lower than they otherwise would have been. Good data across the globe would likely be temporarily ignored (Taiwan and Korea’s 4Q GDP beat expectations by large margins underscoring the electronics recovery). Pay positions and steepeners would become attractive if 10Y US yields drift closer to 1.7%.  

    Credit: Hong Kong’s rating downgrade—limited impact expected

    Moody’s downgraded Hong Kong to ‘Aa3’  from ‘Aa2’ yesterday. The rating firm cited its diminished assessment of Hong Kong’s institutional capacity as a reason for the rating cut, with the government seemingly unable to address issues fostering persistent unrest. This marks Hong Kong’s second rating downgrade since the beginning of mass protests, with Fitch having also downgraded Hong Kong to ‘AA’ last September. While the current fiscal year and FY20-21 are expected to see deficits due to the government’s economic support measures and a drop in land sales, Hong Kong’s credit quality is still fundamentally strong. Its fiscal position is buttressed by over HKD1trn of fiscal reserves (36% of GDP), and the territory has been a paragon of fiscal discipline,  running fiscal surpluses over the last 15 years.

    Thus, the downgrade should result in only minimal impact on the Hong Kong government and corporate bond market. Market data show that Hong Kong’s investment grade bonds have seen only small changes in their option-adjusted spreads (OAS) post the downgrade, with the average increase being just 1.1bps across 18 issues.  This is in line with the muted reaction following Fitch’s downgrade on 5 Sep 2019, with Hong Kong IG bonds’ average OAS only rising by 3.4bps in the week after the downgrade. In short, Hong Kong’s fiscal position remains firmly secure for now, but risks of a slow burn are certainly set to increase, the longer protests continue unabated.

    Eugene Leow

    Rates Strategist - G3 & Asia

    Chang Wei Liang

    Credit & FX Strategist

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