Yuan appeal fades in Hong Kong as local rates hit 14-year high

China's yuan is losing support from Hong Kong investors as the city's monetary authority follows the Federal Reserve in hiking rates, reducing the currency's attractiveness versus the local dollar.

The city's tighter monetary policy has pushed the three-month Hong Kong interbank offered rate to the highest since 2008, widening its gap with a similar gauge for the offshore yuan to nearly a record high. That sent the offshore yuan - Hong Kong dollar currency pair to 1.13 this week, the lowest in two years. 

Yuan-denominated deposits held by Hong Kong residents have also slumped 26 per cent from a peak in January. The events mark a U-turn from last year, when the demand for the currency surged at the fastest pace since before a shock devaluation in 2015. It also threatens to undermine Beijing's efforts in maintaining Hong Kong as a key offshore yuan centre as part of its currency internationalisation push.

The Hong Kong Monetary Authority has drained more than 60 per cent of the city's aggregate cash balance since May in an effort to push up local rates closer to those in the US to maintain its currency peg. Its aim is to deter carry trades that involve shorting the Hong Kong dollar versus the higher yielding greenback and keep the currency boxed in a range of 7.75-to-7.85 per dollar.   

"Eventually Hong Kong rates may catch up with the US rates surge and the yield differential may favour Hong Kong dollar over the offshore yuan, assuming the People's Bank of China continues to keep liquidity ample and follow an accommodative monetary policy," said Stephen Chiu, Asia FX & rates strategist at Bloomberg Intelligence in Hong Kong. He sees the Hong Kong dollar testing 1.1 per yuan or even the 2020's low of 1.08.

Meanwhile, headwinds for yuan are are on the rise. In addition to a widening monetary policy gap with major economies, the lockdown in Chengdu, power shortages and turmoil in the property sector are also weighing on the currency.

Banks including Goldman Sachs Group, UBS and Nomura Holdings expect the yuan to further slide past 7 per dollar. Hong Kong dollar is Asia's top performer this year versus the greenback with a loss of 0.7% while the offshore yuan ranks seventh with a drop of nearly 8% over the same period.

The near-term rise in Hong Kong dollar's three-month Hibor rate may be a sign that local corporates are swapping the offshore yuan into the Hong Kong dollar, according to Cindy Keung, an economist at OCBC Wing Hang Bank. Hong Kong dollar liquidity is still ample with the aggregate balance stabilising in the absence of major initial public offerings, she said, adding that rates could rise on increased demand instead of lower supply under the context of yuan depreciation and positioning for further Fed rate hikes. BLOOMBERG

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