Morning Brief – Turning Tides

Turning Tides

The protests in Hong Kong, tensions between the territory and China, and the mainland and the United States in turn, all encouraged speculative flows out of the Hong Kong Dollar as investors raised the possibility of the USDHKD peg breaking. The tide has turned for the Hong Kong Dollar with the pair now scraping along the floor of its permitted trading band. The Hong Kong Monetary Authority (HKMA) conducts open market operations in order to buy or sell the territory’s Dollar to maintain its value between 7.75 and 7.85 HKD to the USD. The HKMA usually affords the territory a higher interest rate to defend against speculative outflows towards the greenback. Now though the combination of a falling Dollar, a positive interest rate differential and an equity market rebound is putting pressure on the peg to move lower.

The riots in Hong Kong were so severe that the public and financial markets alike were concerned for the fate of commercial activity in Hong Kong. With protests in the street gathering intensity day by day and authorities seemingly impotent against their protestation, speculative trades against the Hong Kong Dollar became common place. The speculative positions taken out in response to the riots even crowded out the forward market so severely as to push the pair outside of its narrow trading range even short dated tenors. Despite the severe tide pushing against the breakwaters of the Dollar’s peg, the spot price never deviated from its range.

Today, with the pair trading right at the bottom end of its 7.75-7.85 range there are increasingly strong forces afoot that are appreciative for the territory’s currency. In fact the HKMA has provided a level of support to the HK Dollar not seen since 2009 when a normalisation of global financial conditions following the Great Recession caused a strong flow back into Hong Kong. The HKMA has conducted open market operations some 40 times so far this year selling a total of HK$132bn to stabilise the pair. The combination of an interest rate differential in favour of the Chinese territory and strong demand for Hong Kong’s equities overseas is unbalancing supply and demand for the currency, forcing the HKMA to step in to level the scales.

Jay Powell’s speech at the Jackson Hole forum last week hit interest and inflation rate expectations hard, making the US Dollar less attractive from a real yield perspective. With the Hong Kong Dollar proving to be a stable store of value versus its US counterpart whilst carrying a nominal interest rate more than 0.5% higher, money has flowed rapidly across the pair. The peg has faced many challenges since its inception in 1983 and today’s challenge seems of little threat to the HKMA. Forward prices are relatively stable today and it is infinitely easier to depend against speculative flows in favour of the domestic currency than frenzied turns out of favour.

Discussion and Analysis by Charles Porter

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