Why Hong Kong inflows are getting unsustainable

Enjoy the liquidity while it lasts.

Amid the significant bounce of funds that flowed into Hong Kong during 2Q and the subsequent intervention of the Hong Kong Monetary Authority (HKMA) with regard to this, it has been warned that these inflows are not sustainable.

According to a report from UBS, funds flowing into Hong Kong bounced significantly in 2Q after five quarters of outflows or very subdued inflows, and that it estimates inflows hit HKD200-220bn during 2Q. This has subsequently prompted the Hong Kong Monetary Authority (HKMA) to intervene and buy USD from banks at 7.75 per HKD since July, which boosts domestic liquidity in the economy.

However, HKMA intervention does not necessarily mean an uptrend in Hong Kong liquidity as some might think, the report noted.

Recent HKMA intervention is largely a result of the inflows that mostly occurred in 2Q. Trend in fundamentals will not support persistent liquidity inflows, in UBS' opinion.

Here's more from UBS:

The resumption of inflows last quarter is due to some positive developments in fundamentals, in particular a bounce in optimism in Chinese policy and economic growth.

These improvements are modest and we think temporary.

The most dominant fundamental headwind for Hong Kong liquidity remains unchanged--an expected tightening in US rates.

UBS expects the Fed to hike by mid-2015 and projects the US policy rate to rise 100bps to 1.25% by the end of 2015.

This, coupled with the city's own excesses, namely high household leverage and over-extended residential property prices, unfortunately still paints a challenging medium-term picture for liquidity, despit the recent surge in inflows.