What Could Come Next Regarding Hong Kong: Here Is The Nuclear Option

What Could Come Next Regarding Hong Kong: Here Is The Nuclear Option Tyler Durden Wed, 05/27/2020 - 19:56

Authored by Ye Xie, macro commentator for Bloomberg

Wednesday’s trading further proves that economic re-opening trumps rising tensions between the U.S. and China. The new battleground between the two superpowers over Hong Kong is a regional, rather than global, risk.

The U.S. markets shrugged off the Trump administration’s threat to revoke Hong Kong’s special trading status Wednesday, with the Dow Jones Industrial Average rising more than 2%.

Value stocks and small caps continued to outperform, pointing to optimism toward an economic recovery.

In comparison, the $1.1 billion iShares MSCI Hong Kong ETF fell 1.4% in the U.S., while the Hong Kong dollar weakened in the forward market. But it’s a more muted reaction compared with the ETF’s 5% loss Friday when news broke that China was set to pass a national security law governing Hong Kong, suggesting the U.S.’s response was largely expected.

The offshore yuan briefly matched a record low before settling down at 7.18 per dollar. Implied volatility remains fairly muted, signaling that investors are convinced there’s limited room for large depreciation as the PBOC stands to contain the fallout.

Are markets too complacent? Maybe. But the experience last year suggests that the only thing that matters for global markets is trade and tariff-related risk. As long as the two countries refrain from slapping more tariffs on each other, things such as America’s human rights bill supporting Hong Kong and blocking Huawei’s market access are irrelevant in deciding how strong the global economy will be.

What could come next regarding Hong Kong?

The U.S.-Hong Kong Policy Act of 1992 allows the city to be exempt from Trump’s punitive tariffs on China and grants it access to sensitive technologies. In theory, the administration could revoke the previlege on both fronts.

But as a first step, the U.S. may come out with "a lot of tough talk and financial sanctions and visa restrictions on Chinese officials who probably weren’t dumb enough to keep funds in the U.S.," said David Loevinger, a former China specialist at the U.S. Treasury who’s now an analyst at TCW Group.

“They will hold back some of the bigger guns like tariffs, export controls and investment restrictions until they see what the new law looks like and how it’s implemented.”

The nuclear option would be “block Chinese banks from the U.S. dollar clearing system,” which is unlikely at this stage, according to Enodo Economics.

Hong Kong assets will struggle amid uncertainties about the enactment of the national security law, and events including the Legislative Council elections in September. At the same time, stock valuation is inexpensive, suggesting room for large declines is limited.

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What Could Come Next Regarding Hong Kong: Here Is The Nuclear Option