Hong Kong steps up defence of FX peg as fixed range tested again
The Hong Kong dollar has been through a rollercoaster ride in recent months, swinging between both ends of its trading range
[HONG KONG] Hong Kong’s de facto central bank ramped up purchases of the city’s currency as it sought to defend a peg that has been strained by volatility in the greenback.
The Hong Kong Monetary Authority (HKMA) bought HK$20.02 billion (S$3.2 billion) of the city’s currency after indicative pricing suggested the local dollar touched the weak end of its permitted trading range in late New York trading. That’s more than double the HK$9.42 billion it purchased last week.
The Hong Kong dollar has been through a rollercoaster ride in recent months, swinging between both ends of its trading range. And for the first time since the current band came into effect in 2005, the authorities had to defend the peg on both sides within just one year.
The wild swings have also intensified debate about the sustainability of the currency’s peg, even though there are no signs that a change is imminent. Market watchers had talked about the possibility of widening the narrow peg, linking the Hong Kong dollar to the renminbi or even free-floating the currency altogether.
To keep the Hong Kong dollar in the allowed trading range against its US counterpart, the HKMA absorbs flows by taking the opposite side of trades once they reach either end of the band. That intervention automatically results in either a withdrawal of liquidity from the market, if it’s buying Hong Kong dollars to support the currency, or an addition of liquidity if it’s aiming to prevent gains. The changes in liquidity, in turn, have a knock-on impact on lending rates in the economy.
In May, a slump in the greenback spurred a rush for Hong Kong’s currency, prompting the HKMA to flood the financial system with cash in an effort to cool the rally that threatened the 7.75-per-US dollar strong end of the band. The operation, however, triggered a sharp reversal of the city’s US dollar and it plunged all the way to 7.85, the opposite end of the trading range.
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Still, even after the latest round of intervention this week, Hong Kong’s aggregate balance – a component of its monetary base – will only fall to HK$144.2 billion. That means the supply of cash will remain abundant and local funding costs are still low.
Therefore, the so-called carry trade, which involves traders borrowing the Hong Kong dollar cheaply and selling it against higher-yielding greenback, is still lucrative. So the local currency can still hit the weak end of the band again soon, analysts say.
“It may take more time for liquidity conditions to normalise this time around, and intervention will go on as long as flush liquidity condition continues,” said Andy Ji, a strategist at InTouch Capital Markets.
Reaction in local rates remained muted on Wednesday (Jul 2). Hong Kong dollar’s one-month interbank rates, known as Hibor, are little changed at 0.72 per cent, despite the HKMA’s liquidity drainage. The spread between one-month Hibor and its US counterpart remains wide at about 360 basis points.
“The Hong Kong Monetary Authority may need to stay on FX intervention watch for an extended period as short-term HKD rates are showing little indication of rising to a level which would dissuade currency bears,” said Mark Cranfield, Markets Live Strategist, Singapore.
The Hong Kong dollar’s move to the weak end of its trading band is in line with the workings of the Linked Exchange Rate System, HKMA chief executive Eddie Yue said in a statement in late June.
“We will see more intervention – with that attractive carry, the question is when, not if,” said Ryan Lam, head of research at Shanghai Commercial Bank in Hong Kong. The one-month Hibor will gradually normalise towards 2 per cent by year end, he expects.
The Hong Kong dollar was little changed at 7.8499 on Wednesday. BLOOMBERG
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