Morning Brief – Tuesday 11th

Morning Brief – Tuesday 11th

Tue 11 Jun 2019

Currency Manipulators



It’s become a bit of a theme of late. Twitter exchanges between the leader of the United States of America and the de facto voices of China’s state-run media frequently weigh in on the manipulation debate. 7 and 7.8 are the key numbers in this game and command the attention of Trillions of private and public US Dollars.


Labelled currency “pegs”, the artificial fixing of the quantity of one currency in terms of a fixed volume of another is employed by countries in order to produce certainty in the import/export markets and frequently to artificially skew a current account balance (to favour exports and domestic consumption, over imports). The strategy also affords protection against the speculation of international markets on a nation’s currency that can have disastrous consequences. All’s hunky-dory, eh?! Let’s all go and manipulate our currencies!? 


Well, no. Cast this unilateral thought into an international arena. Consider: Porterbaijan-ian Pesos (PBP) are fixed at an exchange rate of 2 to the US Dollar whilst Percian Peseta’s (PCP) are fixed at 3 to the US Dollar. That means a PBP/PCP FX cross should trade at 1.5. So, the exports from Porterbaijan are relatively more expensive given the exchange rate so, all things equal, no one is going to buy from me them. My their current account balance (imports – exports) will therefore suffer, economic growth will fall and the People’s Bank of Porterbaijan will struggle to maintain the peg to the Dollar. It doesn’t take a genius at this point to work out that the PBP will be artificially devalued further, promoting cross border inflows of USD and PCP in order to purchase my their exports. But guess what? Stretch this game out and we’ll all just keep cutting and cutting until we all realise our currencies are worth nothing. This is the risk, the inequity and ultimately the reason why it has become frowned upon to be labelled a currency manipulator.


Some of the greatest currency trades of all time have come as a result of a peg breaking; George Soros vs. The Bank of England saw over a billion Pounds made off of a ‘single’ trade that went long the Deutsche Mark. When the peg between the Euro and the Swiss Franc at 1.20 was finally ditched in 2015, the Swiss Franc picked up 19% in a single day. I think it’s time another gave up the ghost. 


The Hong Kong Dollar (HKD) exchange rate manipulation efforts have successfully kept the HKD around 7.8 against the US Dollar (USD) for 36 years. The fixing was adjusted this millennium to trade in a band of 7.75-7.85 partially to reintroduce automatic stabilisers to demand side economic shocks but also to appease the critics of explicit currency manipulation on the international stage. The endeavour has been expensive, however, I don’t think the pair has ever faced as significant a challenge as it might now. It’s a trade war story.


With an economy heavily exposed to the financial services sector, the guarantee of a stable exchange facility between the Hong Kong Dollar and the rest of the world is seen as pivotal by domestic authorities. That view has come at a price. The Hong Kong Monetary Authority’s (HKMA) Aggregate Balance represents the liquidity in the banking system and is heavily influenced by the state’s activity in exchange rate manipulation. Today, according to Bloomberg Data, it stands at its lowest level since 2008 – the heart of the financial crisis. The balance has tumbled since 2015 when it was approaching half a trillion US Dollars and now only stands with its head just above 50B Dollars. If conditions worsen, cash strapped Hong Kong might therefore be forced to unwind spending on maintaining its currency peg and instead inject real money in its economy sending HKD tumbling. 


The USDHKD exchange rate has drifted towards the upper bound of the currency peg as Hong Kong’s currency has come under pressure, and this morning trades only 0.2% off of the magical number and its upper bound. Despite this, options market positioning reveals an increase in call options outside of the band that explains commercial players’ expectations for Hong Kong to potentially default on its commitment to maintain the peg and allow the domestic currency to devalue. What could force this to happen? Upset in the East. And that’s exactly the storm that is brewing.


Only yesterday evening did Trump claim that if President Xi of China won’t meet him at the G20 summit later this month then he’ll slap on some more tariffs. The trade war has slashed economic forecasts of global, US and Chinese growth. The forecasts are starting to look real with data in the last month frequently surprising to the downside. The reduction in global commerce by the World bank and IMF is eye watering and Hong Kong’s reliance upon tertiary sector economic output will seriously suffer if the more fundamental levels of economic productivity around the globe are being wiped out. Why the USDHKD peg and not the USDCNY/H peg at 7 then? Well, the answer is that the HKMA doesn’t have over a trillion US Dollars’ worth of the States’ treasury bills stuffed under its mattress to defend itself. 


Lastly consider this (particularly you HKD sellers!): selling the Hong Kong Dollar forward is so-called ‘points on’. You’ll achieve a better rate than ‘Spot’ valuations to sell the currency against the US Dollar. So, head forward a year, escape the (huge) danger of a peg being broken and pick up points whilst you’re at it! No brainier! 





Discussion and Analysis by Charles Porter

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