(Bloomberg) -- Investor confidence in Hong Kong is dwindling as the government loses its grip on an escalating omicron outbreak.
Bearish bets against the city's shares have climbed to records and the benchmark Hang Seng Index is near a two-year low. Residents are converting the local currency into China's yuan at the fastest pace in more than a decade, while the Hong Kong dollar is moving toward the weak end of its trading band against the greenback. Even the city's typically resilient property market is showing cracks, with a gauge of home prices falling to an 11-month low.
After enduring some of the world's strictest quarantine regulations under the city's Covid-Zero policy for almost two years, Hong Kong residents are now facing one of the deadliest outbreaks. Over 225,000 infections have been recorded in the current wave, though Hong Kong University researchers estimate that the true count is about 1.7 million people -- almost a quarter of the financial hub's population.
“Nobody knows where the government is going,” said Simon Powell, a Hong Kong-based equity strategist at Jefferies Group. “If you're a Hong Kong trader or fund manager, you've had a shocker -- the performance has been awful. Throw into the mix that you're probably home schooling and your family is scared of getting sent to a quarantine camp and you might even be sick ... people are having a terrible time.”
Many have had enough. There were 43,689 net departures from the city in the past two weeks, the most since the start of the pandemic, according to government data. In a bear case -- where the Covid outbreak peaks late in the second quarter -- Bank of America Corp. analysts estimate 2-3% of Hong Kong's population could depart every month.
Hong Kong's Covid Crisis Set to Push Economy Into Contraction
There are signs that the growing stress on people and financial markets is worrying authorities. The city's banking regulator told finance executives it's lobbying the government to shorten quarantine for inbound travelers, people familiar with the matter said. In a statement posted late Tuesday, the government suggested it would ensure financial markets remain open during a potential citywide lockdown.
Officials are planning to restrict the movement of residents for four days at the end of March during a mass testing exercise, according to local news outlet HK01 Wednesday. Concern that the government would impose a lengthy lockdown imminently has prompted panic buying of everything from food to painkillers.
Despite two years of planning, the virulence of the outbreak has caught officials by surprise. The financial hub averaged eight deaths per 1 million people over the past 10 days, the most among advanced economies, according to Bloomberg calculations based on Johns Hopkins University data. While most major Western countries are past the peak of their latest wave of infections, Hong Kong's current ratio is close to surpassing the nine deaths per 1 million that the U.S. recorded at the peak of its omicron wave in January.
Sentiment among investors is deteriorating just as the U.S. Federal Reserve is set to increase interest rates for the first time since 2018, which will force Hong Kong to follow due to its currency peg. That will increase the cost of mortgages in Hong Kong and pressure home prices, which BofA predict will drop as much as 10%.
The Hang Seng Index this week dropped to the lowest level since March 2020. Bearish speculators are driving about 16% of total activity in the city's $6 trillion equity market-- the highest proportion on record -- according to the 50-day moving average. Short interest on the U.S.-listed iShares MSCI Hong Kong exchange-traded fund has risen to 20% of shares outstanding, the highest in IHS Markit Ltd. data going back to 2006.
Shares of the exchange operator Hong Kong Exchanges and Clearing Ltd. -- which has in recent years become a proxy for market sentiment in the city -- has fallen 14% in nine days, the longest losing streak since 2015. The company last week said profit dropped for a third straight quarter, with Chairman Laura Cha saying restrictions on travel, interest rate hikes and uncertainty over the pandemic will pose a challenge.
In money markets, one-month and three-month interbank rates have climbed to the highest levels since late 2020 as liquidity tightens. A gauge of expected swings in the Hong Kong dollar is near its highest in more than a year. Analysts at BNP Paribas SA and BofA this week predicted the currency will near the weak end of its trading band with the greenback at 7.85. A sustained weakening could prompt authorities to defend the currency's peg, further mopping up liquidity and sending borrowing costs even higher. That would affect everything from mortgage rates to corporate funding.
Markets around the world have been roiled by Russia's invasion of Ukraine, as well as the resulting sanctions and efforts to restrict Moscow's access to funds. Global stocks lost more than $7 trillion in 14 days, while the cost of converting currencies like the euro and the yen hit the highest since the early days of the pandemic.
Inflows from onshore investors can help offset the impact of capital flight and support the Hong Kong dollar, BNP analysts led by Ju Wang wrote in a Tuesday note. The city's regulators are considering easing listing rules for some companies, which may accelerate the homecoming of Chinese tech firms from the U.S.
Mainland-based funds have snapped up more than $1 billion worth of Hong Kong stocks in the past five days, according to exchange data compiled by Bloomberg. A similar phenomenon happened in the wake of the national security law in mid-2020, which propped up Hong Kong's financial markets.
Being bearish on Hong Kong's markets and economy is becoming consensus. The risk is that positioning turns so one-sided that investors get caught wrongfooted if Hong Kong's outbreak ends earlier than expected, or if Beijing allows the city to abandon its Covid-Zero strategy.
There's little evidence either scenario will come true any time soon. Hong Kong reported 117 deaths on Tuesday and 32,597 new cases. The total number of deaths could surpass 4,645 by the end of April, according to the Hong Kong University report.
Ending Covid Zero would require approval from Beijing. Chinese President Xi Jinping told local authorities in February that halting the outbreak is “a mission that overrides everything.”
©2022 Bloomberg L.P.
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