Here's why a more dovish Fed is a temporary relief for Hong Kong

Will this affect headwinds?

UBS has mentioned that its US economics team had lowered their expectations on the pace and timing of US rate hike on the back of the recent US FOMC meeting.

According to a research note from UBS, it now expects the Fed to delay the first hike to September (from June previously) and reduces the magnitude of increase this year to 50bps from 100bps earlier.

By end-2016, UBS expects the Fed funds rate to reach 2.125%, down from the original 2.75%. For Hong Kong, which is importing the Fed policy via the HKD peg, a more dovish Fed might offer temporary relief but it does not change the fundamental headwinds facing the city.

The report noted a reminder from Singapore, in line with the cited developments. Interbank rates have increased by 60bps in Singapore to 1.0% since late 2014, despite no change in the US policy rate. This, coupled with falling inflation, has pushed real interest rates back to positive since late 2014.

The property market has finally yielded to rising interest rates and the cocktails of policy tightening, in particular Singapore's aggressive supply response to housing shortage and the numerous rounds of aggressive macro-prudential measures, with residential property prices having fallen 5% since late 2013.

Here's more from UBS:

No independent interest rate policy - Singapore and Hong Kong share many similarities and that’s why Singapore can serve as a potential roadmap for Hong Kong. Both Singapore and Hong Kong are small and open cities heavily dependent on services.

More importantly, both cities target the exchange rate, leaving domestic interest rate dependent on foreign interest rate policies and currency expectations.

Both cities had undergone a prolonged period of rapid credit expansion and wrestled with an overheating property sector, as they imported the ultra-loose US monetary policy through their respective exchange rate arrangements since 2009.

The exchange rate regimes in Singapore and Hong Kong differ, but the core mechanism and their links to US monetary policy are similar. Hong Kong is at the extreme, with the HKD pegged to the USD within very narrow trading bands.

The Hong Kong Monetary Authority (HKMA) has no discretion whatsoever as the peg is self-operated on rules. Singapore has a bit more flexibility and discretion. The SGD is managed against a basket of currencies, not a single currency, although the USD and in turn US interest rate policy should have the biggest influence.

The Monetary Authority of Singapore (MAS) also enjoys more discretion. The SGD is not pegged at a fixed rate and the MAS is mandated to conduct monetary policy through exchange rate management.

But by targeting the exchange rate, both Singapore and Hong Kong are similar in importing foreign interest rate policy. For HK, it is from the US. For Singapore, it is mostly the US plus other key trading partners.