- US-China yield gap widens, but inflows show investors remain focused on long-term diversification.
- Yuan stability vs weaker USD supports China’s attractiveness amid global de-dollarization efforts.
- HK rates benefit from the USD peg, offering relative rate stability.
- Ample liquidity fuels demand for HKD bonds, easing upcoming issuance pressures.
- Lower HIBORs and improved valuations may boost HKD bond and equity issuance.
Related Insights
Commentary: Case for China and HK rates
The erosion of confidence over USD assets have built a strong case for Asia bonds. The increasing odds of earlier-than-expected Fed’s cuts are also motivating investors to look for alternatives in the region. Major currencies have stabilized, paving the way for more aggressive cuts from Asia central banks. Amongst all, China bonds received most of the inflows amid its gigantic market size. It also serves as an alternative haven asset to its USD counterpart. Hong Kong rates are another key beneficiary, thanks to the HKD peg system.
China
China recorded a notable pickup in capital inflows in May, with non-bank sectors contributing US$33bn—nearly double April’s US$17.3bn. Bond inflows rose sharply, climbing from US$1.5bn to US$5.6bn, likely reflecting a growing skepticism over US Treasuries and a shift toward alternative safe assets.
Despite a widening US-China yield gap, recent inflows point to investors’ longer-term focus on diversification. The yuan’s relative stability, especially compared to a weaker US dollar—reinforces China’s appeal amid a broader de-dollarization trend. In our view, foreign participation in the Chinese bond market could trend back toward the 3% share last seen in 2021 from 2.4% currently.
These inflows, coupled with May’s easing measures—including a 10bp policy rate reduction and a 50bp reserve requirement ratio cut injecting RMB 1 trn—suggest the PBOC can afford to stay on hold in the near term to evaluate policy transmission, particularly with trade tensions easing under the current “tariff truce”. However, subdued domestic activity, elevated real interest rates, heavy bond issuance, and large upcoming medium-term lending facility maturities point to further easing ahead. We expect an additional 20bp cut in the 1Y LPR and another 50bp RRR reduction in 2H25, helping anchor short-end yields and steepen the CGB curve.
Hong Kong
Along with the appreciation of other Asian currencies, USD/HKD reached the strong side of its 7.75 trading band in May. The Aggregate Balance jumped almost fourfold to HKD174bn from HKD44bn. Consequently, 1-month HIBOR plunged from 4.06% in April to around 0.5% recently. While HIBOR has been rebounding due to quarter-end effects and HKMA intervention to buy HKD at the weak side of the band, HKD rates will likely remain substantially below their USD counterparts. The Aggregate Balance is expected to remain ample, above HKD 120bn in the near term.
In our view, the 3M HIBOR-SOFR differential could widen from approximately 50bps to approximately 150bps if the terminal Fed Funds Rate reaches 3.50%. Such a spread could discourage aggressive arbitrage (the FX risk of 7.75-7.85 is roughly 130bps). 3M HIBOR should settle at 2.30% by the end of 2025 after the initial HKMA intervention at the weak side of the trading band. 1M HIBOR will also maintain a much wider spread, around 80bps, against the 3M tenor given the ample liquidity.
Flush liquidity is translating into demand for HKD bonds, which will soothen the upcoming issuance. According to the government budget announced in February, public debt as a percentage of GDP is expected to increase only modestly, from 9% to 16%. Tight HKD government bond supply, which has contracted by 37% since the end of COVID, will help contain yields. The Financial Secretary also projected that the city would return to a fiscal surplus after three consecutive years of deficits, further bolstering the case for HKD govvies.
Lower HKD rates will also help ease credit risk and support overall credit demand, as banks enjoy cheaper access to wholesale funding. The reversal of SHIBOR-HIBOR spreads is also fueling lending to Mainland China. However, still-weak economic fundamentals could restrain credit demand. Empirically, loan demand lags HK GDP growth by 4 quarters. The jobless rate is currently rising amid ongoing business closures. In capital markets, both bond and equity issuance should gain traction with lower HIBORs and higher valuations. The number of IPOs in the pipeline reached 187 of late. Meanwhile, Hang Seng Index is returning to 24,000 levels along with rising M2.
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