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The big Hong Kong dollar short is bruised, but not broken

[HONG KONG] Hong Kong dollar bears are down, not out. So say Credit Agricole CIB and DBS Hong Kong after the biggest jump by the pegged currency in 19 months.

The main factors weighing down the exchange rate haven't gone away, with ample liquidity causing a wide interest-rate discount to that on the greenback. Low volatility due to a peg to the US currency and cheap funding costs also make it an especially appealing short.

"Interest in shorting the Hong Kong dollar might have fallen slightly, but it's still there because it's not like there are expectations of a US rate cut," said Tommy Ong, managing director for treasury and markets at DBS Hong Kong Ltd.

"Although US rates aren't going up, Hong Kong rates haven't caught up on the short end."

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The exchange rate posted its biggest two-day jump since January 2016 on Friday as a tumble in the greenback forced investors to unwind short positions on the Asian currency.

Traders were already shaken out of their complacency once in August when the Hong Kong Monetary Authority announced additional debt sales, a move that pushes up rates.

Although the market is pricing in a slower pace of US rate hikes, there are no signs that liquidity in Hong Kong will tighten significantly even after the debt issuance, as factors such as equity inflows from mainland China continue to hold.

The premium of US rates over Hong Kong reached the most since 2008 just last Thursday.

Twelve-month forward points - a reflection of expectations for the spread - plunged to a nine-year low last week, driving the outright contracts to trade as strong as HK$7.7353, outside the spot rate's HK$7.75-HK$7.85 band against the greenback.

This means being long the US dollar via such forwards will be profitable as long as the peg doesn't break.

The Hong Kong dollar spot rate was almost flat on Monday at HK$7.8140, after erasing gains of as much as 0.25 per cent Friday.

"Liquidity still remains quite flush," said Gary Yau, a strategist at Credit Agricole in Hong Kong.

"If you look at the interest-rate differential, higher US dollar against Hong Kong dollar still makes sense."