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Mystery 0.6% rise in HK dollar jolts city's sleepy FX market

Hong Kong

IN a year of currency surprises from Turkey to Argentina, add another shocker to the list: a 0.6 per cent rise in the Hong Kong dollar.

The former British colony's sleepy foreign-exchange market suddenly came to life on Friday, propelling the local dollar to its biggest gain in 15 years.

In a city that keeps its currency on one of the world's tightest leashes, swings greater than 0.4 per cent have only happened three times since Hong Kong widened its trading band in 2005.

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"The strengthening came as a huge surprise," said Wu Mingze, a Singapore-based trader at INTL FCStone Global Payments.

The trigger for Friday's gain is still something of a mystery. Theories include rising local borrowing costs, position adjustments before upcoming holidays and a buying stampede by short sellers hit with stop losses.

Traders who've been selling the Hong Kong dollar to buy higher-yielding US assets face a painful squeeze, particularly if they loaded up on leverage to amplify returns.

"Shorting the local currency has been a crowded trade," said Ngan Kim Man, co-head of treasury at China Everbright Bank's Hong Kong branch.

"There could be another round of Hong Kong dollar gains" as international traders wake up on Friday and unwind their positions, he said.

Derivatives dealers are already bracing for more volatility: a gauge of expected price swings derived from the options market more than doubled on Friday.

Potential catalysts for further turbulence include an expected US Federal Reserve interest rate hike later this month and an increase in Hong Kong banks' so-called prime rate - something that hasn't happened since 2006.

The Hong Kong Monetary Authority (HKMA), the city's de-facto central bank, said in a statement on Friday that it will continue to maintain the Hong Kong dollar's link to the greenback.

Foreign-exchange and money markets are operating in an orderly manner, HKMA said, adding that market participants generally viewed elevated interbank rates as a contributing factor to the strengthening of the local dollar on Friday.

The risk for Hong Kong is that higher borrowing costs trigger a downturn in the city's property market, which is by some measures the world's most expensive.

Home prices in the city, where real estate is practically a religion, have soared 16 per cent over the past 12 months, extending a relentless upward march for most of the last 15 years, according to a Centaline Property Agency index.

A jump in outstanding mortgages pushed the city's household debt-to-gross domestic product ratio to a record in the second quarter.

The Hong Kong dollar, which is subject to a trading band of HK$7.75 to HK$7.85 versus the US dollar, has been stuck near the weak end of that range for the past six months, due in part to selling by carry traders.

But that dynamic may now be starting to change: the difference between the city's three-month interbank borrowing costs and those of the US has narrowed by nearly one percentage point since March, when the gap reached its widest in a decade.

On Friday, the currency climbed as much as 0.6 per cent to HK$7.7930 per greenback, the strongest level since November, before paring gains to trade 0.4 per cent higher at 5.30pm in Hong Kong.

The Hong Kong dollar's three-month interbank borrowing cost, known as Hibor, jumped to the highest level in nearly a decade.

"Traders may have come to believe the interest rates will keep rising, with some of them unwinding short-Hong Kong dollar carry trades, and that triggered stop losses and a stampede," said Tommy Ong, managing director for treasury and markets at DBS Hong Kong.

His near-term forecast for the exchange rate - somewhere between HK$7.80 and HK$7.83.

Sue Trinh, head of Asia foreign-exchange strategy at Royal Bank of Canada in Hong Kong, predicts Friday's move will be short-lived. She sees the currency weakening again as the city's economic growth slows alongside China's.

"In the longer term, the gains are not sustainable," she said. "The Hong Kong dollar will be back to HK$7.85 in due course." BLOOMBERG