Guotai Haitong: What does the strengthening of the US dollar mean for Hong Kong stocks?

Guotai Haitong released a research report stating that the recent strength of the US dollar is mainly due to the US government shutdown resulting in a "dollar shortage", the hawkish tone of the Federal Reserve, and the weakness of non-US currencies. Historically, a strong US dollar has put pressure on outflows of foreign capital from the Hong Kong stock market. Additionally, under the linked exchange rate system of the Hong Kong dollar, it may have a short-term impact on local liquidity and local sectors. In the short term, attention should be paid to the timing of the US government reopening and economic data. In the medium term, Hong Kong stocks with incremental capital inflows and a concentration of high-quality assets are expected to reach new highs, with a focus on the technology sector in Hong Kong stocks. Guotai Haitong's main points are as follows: What does a strong US dollar mean for Hong Kong stocks Since the end of September, the US dollar index has strengthened, surpassing the 100 level on November 4, reaching its highest level since July this year. Foreign capital still plays an important role in the Hong Kong stock market, so the movement of the US dollar has a significant impact on the liquidity of Hong Kong stocks. In the current context of a strong US dollar, the performance of Hong Kong stocks has also been relatively volatile. So how does the strong US dollar affect Hong Kong stocks? How should we view the future market trend? This article will analyze these questions. Recently, factors such as the hawkish stance of the Federal Reserve and tight liquidity in the US dollar have led to the strengthening of the US dollar index. In the first half of this year, due to the weakening of the US economy and the impact of global trade friction ignited by Trump, the US dollar index fell rapidly. In July, the US dollar rebounded, but under the expectation of rate cuts, the US dollar weakened again. However, since the end of September, the US dollar index has fluctuated and strengthened, now reaching a preliminary high level since July of this year. Guotai Haitong believes that the main reasons behind the recent strength of the US dollar are as follows: First, the US government shutdown has caused a tight US dollar liquidity. Since the beginning of October, the US government shutdown has resulted in stagnant government spending. As of October 29, the total account balance of the Treasury Department quickly rose to $1.0 trillion, compared to a low of $0.3 trillion in June, pulling approximately $0.7 trillion in liquidity from the market. At the same time, the Federal Reserve is still reducing its balance sheet, which further exacerbates the "dollar shortage". The spread between the overnight financing rate secured by the US and the Federal Reserve's excess reserve rate quickly widened to a new high of 32 basis points in the last 20 years, tightening liquidity has become an important driver of the strengthening of the US dollar. Second, Federal Reserve Chairman's hawkish remarks have cooled expectations of rate cuts. After the October FOMC meeting, Federal Reserve Chairman Powell stated that a rate cut in December is "far from a done deal", triggering a rapid cooling of market expectations for easings this year. According to fed watch tools, the probability of a rate cut in December has dropped rapidly from over 90% before the meeting to the current 61.5%, while the 10-year US Treasury bond yield has risen from 3.98% to 4.17%, providing upward momentum for US dollar by raising the bond yield. Third, non-US currencies, represented by the yen, have been relatively weak. The recent weakness of non-US currencies has also supported the strength of the US dollar: in terms of the yen, high mustard being elected as Japan's Prime Minister. The new government tends towards fiscal expansion and dovish monetary policy; the Bank of Japan maintained interest rates in October, sending a signal of caution, which exacerbated the depreciation of the yen. As for the pound, weak wage and inflation data, combined with the statement by the British Finance Minister that tax increases and spending cuts may be introduced, further increase the economic downturn pressure, pushing the pound down. So what does a strong US dollar mean for Hong Kong stocks? From the perspective of the capital structure of Hong Kong stocks, the Hong Kong stock market is still dominated by foreign capital, which is sensitive to changes in the US dollar. Although foreign capital has been in outflow in recent years, as of Q3 2025, foreign capital still accounted for about sixty percent; at the same time, local Hong Kong funds accounted for close to twenty percent, which is also vulnerable to the impact of the US dollar environment. The following will discuss the historical and current impact of the recent strength of the US dollar on Hong Kong stocks from the perspectives of foreign and local funds. The attractiveness of US dollar assets has increased, leading to pressure on outflows of foreign capital from Hong Kong stocks. Historically, the outflow of foreign capital from Hong Kong stocks has had a high correlation with the US dollar index. Flexible foreign capital is more sensitive to liquidity changes and thus more susceptible to the impact of the US dollar index. Looking back at several rapid strengthening periods of the US dollar index since 2021, during the periods of 2021/12-2022/09 (during which flexible foreign capital net outflows amounted to -111.56 billion Hong Kong dollars, stable foreign capital net inflows amounted to 53.87 billion Hong Kong dollars, and similarly for the following periods of 2023/07-2023/09 (-57.48 billion Hong Kong dollars, -41.12 billion Hong Kong dollars), and 2024/09-2025/01 (-93.72 billion Hong Kong dollars, -212.46 billion Hong Kong dollars), during which flexible foreign capital in Hong Kong stocks were in outflow trends, and even though stable foreign capital tends to lean towards long-term allocations, they may also be influenced in a strong US dollar environment. It is worth noting that this year's foreign capital flow is also related to the US dollar environment: from May to July of this year, during the fermentation of the weak dollar logic and the easing background of the China-US negotiations, both long-term and short-term foreign capital flowed back to Hong Kong stocks, but after July, the US dollar index rebounded. Additionally, the uncertainty of the China-US negotiations resurfaced, and the flow of foreign capital became somewhat erratic. The recent strength of the US dollar has caused some disturbance to foreign capital in Hong Kong stocks. Since the end of September, foreign capital has experienced a net outflow of 79.18 billion Hong Kong dollars, of which flexible foreign capital is more sensitive to the strengthening US dollar, with a cumulative outflow of 74.57 billion Hong Kong dollars during the same period, while stable foreign capital has a cumulative net inflow of 4.61 billion Hong Kong dollars. Under the linked exchange rate system, the strength of the US dollar may have a short-term impact on local liquidity and local sectors of Hong Kong stocks. The Hong Kong Monetary Authority implements a linked exchange rate system, with the goal of maintaining the Hong Kong dollar exchange rate stable within the range of 7.75 to 7.85 Hong Kong dollars against 1 US dollar. This goal relies on a dual mechanism: first, the HKMA intervention mechanism ensures upper and lower limits; when the Hong Kong dollar exchange rate hits the weak side guarantee of 7.85, the HKMA will passively withdraw liquidity, thereby pushing up the Hibor rate. Conversely, it will inject liquidity to lower the rate. Second, the market arbitrage mechanism adjusts spontaneously; with the free flow of capital between Mainland China and Hong Kong, the difference in interest rates between Hong Kong and the US, capital through risk-free arbitrage behavior, promotes interest rate/ exchange rate adjustments. Similarly, looking back at the three previous phases of the strong US dollar since 2021, the strong US dollar is often accompanied by an increase in US dollar interest rates, pushing up the Hibor rate through market arbitrage mechanisms. If the Hong Kong dollar exchange rate continues to depreciate to the weak side guarantee, the HKMA further impacts local liquidity by withdrawing liquidity as seen in the period of 2021/12-2022/09. Historically, the tightening of local liquidity has also suppressed the performance of local consumer services, real estate, and other sectors. Despite the strength of the US dollar, the Hibor rate has not yet risen, and since August, with the warming of the market's expectations for a rate cut by the Federal Reserve and the rapid inflow of capital from the Mainland China, the Hong Kong dollar exchange rate has at times been close to the strong side guarantee. Currently, the Hong Kong dollar exchange rate is still biased towards being strong, and the HKMA usually only passively withdraws liquidity when the exchange rate touches the weak side guarantee. Therefore, the short-term impact on local liquidity and local sectors may be relatively limited. Pay attention to the timing of the US government reopening and economic data. In October, the Hong Kong stock market experienced a volatile adjustment due to factors such as the resurgence of China-US trade friction, the strengthening of the US dollar index, and the rapid rise in previous prices. At present, several factors pressuring the Hong Kong stock market have made positive changes: first, the positive signals from the meeting between the leaders of China and the US, with the current state of China-US trade negotiations stabilizing, reducing short-term external uncertainties; second, looking at the adjustment period since October, with the maximum decline in the Hang Seng Index being 8.2% and 15.8% for the Heng Seng technology sector, the adjustment phase has lasted for 23 trading days, exceeding the average retractment of previous bull markets; third, even though the short-term US dollar index is still strong and there is increasing pressure from capital outflows, the recent strength of the US dollar is largely due to short-term liquidity factors. Recently, US lawmakers mentioned that the government shutdown is expected to end before the end of the weekend, if the US government reopens, the accumulated liquidity backlog may experience a rapid release, coupled with the market's current expectation of a high likelihood of a rate cut in December, the subsequent rapid rise in the US dollar index may be difficult to sustain. Therefore, attention should be paid to the timing of the US government reopening and the state of US economic data. In the medium term, Hong Kong stocks with incremental capital inflows and a concentration of high-quality assets are expected to reach new highs. After the correction in October, the valuation of Hong Kong stocks is currently not high. If the short-term factors pressuring Hong Kong stocks are relieved, in the medium-term context, the clarity of incremental capital into Hong Kong stocks, coupled with the pool of high-quality scarce assets, is expected to continue supporting the current bull market trend, specifically: Hong Kong stocks have a valuation advantage. At the index level, Hong Kong stocks are at a global low in valuation, with the Hang Seng Technology PE at the 30th percentile since reliable data has been tracked. At the industry level, sectors such as technology in Hong Kong stocks have higher valuation attractiveness compared to A-shares and US stocks. The recent trend in the domestic AI industry has been accelerating, with considerable potential for an increase in the mid-term valuation of Hong Kong stocks from a profit perspective. Hong Kong stocks have a higher degree of certainty in incremental capital inflows. In terms of foreign capital, there are signs that the continuous outflow of foreign capital may have stabilized since the middle of the year. If the Federal Reserve continues to cut rates and China-US trade relations continue to stabilize, the scale of foreign capital flowing back into Hong Kong stocks may exceed expectations. In terms of domestic capital, the pricing power of domestic investors has increased in recent years, with nearly 12 trillion Hong Kong dollars in cumulative inflows from the Mainland South in the past 25 years. Next year, the amount of Southbound funds flowing into Hong Kong stocks is expected to exceed 1.5 trillion Hong Kong dollars, which may continue to drive the upward trend of Hong Kong stocks. Hong Kong stocks have a scarcity of assets. China is currently in a crucial period of transitioning from old to new economic engines, with the backdrop of a slowdown in macroeconomic growth domestically, domestic capital is facing pressures from a lack of assets. Despite the lack of upward elasticity at the macro level, profound changes are occurring at the industrial level. For example, the new wave of AI-led industrial trends in China is deepening, indicating that Hong Kong stocks with assets in scarce assets that align with current industrial development trends, such as AI applications, may hold a competitive advantage. Structurally, under the dominance of AI, the technology sector in Hong Kong stocks is still the main trend. The overseas narrative of "AI empowerment" is expected to gradually transition to the domestic market in China, and the stabilization of Sino-US relations will help improve the market's risk appetite, in addition to the disruption of profit expectations caused by the "subsidy war" among Internet takeaway platforms gradually fading. Leading technology companies in Hong Kong stocks have certain advantages in this AI wave and are expected to benefit fully from the dividends of industrial transformation driven by AI. With the further confirmation of the upward trend of the AI industry cycle, leading technology companies in Hong Kong stocks are expected to regain relative advantages. In addition, innovative pharmaceuticals accelerating their internationalization efforts and realizing performance is worth paying attention to. In recent years, China has been accelerating its efforts to internationalize its innovative pharmaceuticals, and looking ahead, the Hong Kong stocks of the innovative pharmaceuticals sector are expected to transition from an international narrative to a fundamental driver, combined with loose overseas liquidity to drive towards upward space. In addition, under a bull market environment, the securities sector in Hong Kong stocks is also worth noting. Risk Warning: Progress in stabilizing growth policies falls below expectations, international trade environment worsens beyond expectations, Federal Reserve rate cuts proceed slower than expected.