Overnight trading in HKD offered a brief moment of hope for the Monetary Authority as the dollar popped off its peg band’s lower limit after comments from the former HKMA chief Joseph Yam renounced the current HKMA chief’s comments and suggested rate-hikes (to counter the endless flow from the LIBOR-HIBOR carry trade) was room for Hong Kong to adjust interest rates and additional exchange fund bill sales can be an option.
However, that did not last, as the flows just kept coming and HKD was back at the 7.85 to the USD level very quickly.
The Hong Kong Monetary Authority has bought over HKD28.6 billion (USD3.6 billion) since the local currency fell to the weak end of its permitted trading band last week, and as the chart above shows – it’s not working!
There is perhaps a glint of good news for HKMA, as the Hong Kong dollar’s three-month Hibor rate rose to 1.29714%
But, its discount to the greenback’s borrowing costs stayed well above 100bps, which still makes shorting the Hong Kong dollar lucrative.
“The pace of foreign-exchange intervention is not particularly high,” said Frances Cheung, head of Asia macro strategy at Westpac Banking Corp. in Singapore.
“There’s risk of further intervention, and if it is at a similar pace, then the aggregate balance can easily fall below HK$100 billion in one to two months’ time.”
As we explained previously, HKMA has its work cut out to stop this trend as the main culprit behind the local currency’s slump is the carry trade, an arbitrage whereby investors borrow low-yielding currencies to buy high-yielding currencies.
This is an arbitrage, where traders take advantage of differences in prices, selling a low-yielding product (the Hong Kong dollar) to buy a high-yielding product (the US dollar). In this case, the price difference is between the local borrowing cost known as the Hong Kong interbank offered rate (Hibor) and the US borrowing cost known as the Libor.
Simply put, traders are borrowing against the low Hibor, selling the Hong Kong dollar to buy the US currency for investments in high-yielding US assets. The difference between the two is widest since 2008.
As more traders pile on to the carry, more pressure is placed on the Hong Kong dollar, causing it to weaken further against the US currency… and The Fed’s plan to hike rates (as many as four times) will do nothing to help ease the situation – meaning any dollars sold in defense of the weaker HKD will be battling global carry trade flows driven by The Fed’s tightening.
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Finally, as a reminder, as far back as 2010, investors have been arguing over whether the Hong Kong Dollar would be “revalued” higher (out of the peg band) – most notably Bill Ackman’s inflation thesis; or “devalued” lower (below the peg band as it is currently testing) – Deutsche Bank’s Mirza Baig’s view.