On the same day as Hong Kong Monetary Authority (HKMA) Chief Norman Chan urged citizens to “stay calm on the currency weakening,” the Hong Kong Dollar has plunged to its weakest in 33 years amid liquidity concerns and a global carry trade gone rogue.
The Hong Kong Dollar has been in free-fall for the last year (interrupted briefly in the middle of last year) but as its drop accelerated in recent days, HKMA wrote a blog to reassure the people that their paper-money is safe:
Stay calm on the weakening of the Hong Kong dollar
There have been concerns and discussions in the market about the recent weakening of the Hong Kong dollar (HKD).
Chan then goes to to answer some questions (but it seems his headline sparked some sudden selling)…
This is the weakest in 30 years and near the weaker end of the peg band (7.85/USD), but do not worry, Chan says:
“However, this should not cause any concerns, as the HKMA will take action when the HKD exchange rate touches the weak-side Convertibility Undertaking (7.85) to ensure that it will not fall below 7.85.“
Question 3 caught our eye – If the HKMA is not concerned about the weakening of the HKD, why did it issue additional Exchange Fund bills when the HKD was weakening last year? Was it intended to prevent the HKD from depreciating as suggested by some market players?
This is not true. The issuance of additional HK$80 billion worth of Exchange Fund bills by the HKMA last time was solely in response to market demand for highly liquid instruments and had nothing to do with the strengthening or weakening of the HKD.
We do not have plans to issue additional Exchange Fund bills for the time being and hope that market players will not take it wrongly that the HKMA does not want the HKD to weaken.
In fact, with the widening of the spreads between HKD and USD interest rates, we are looking forward to funds flowing from the HKD into the USD, causing the HKD exchange rate to reach 7.85, a level where the HKMA will take action. This will allow the Monetary Base to contract gradually and create an environment conducive to the normalisation of HKD interest rates.
Which – roughly translated from double-negative google translate into English – means…feel free to ride this trend lower, but at 7.85 we will unleash hell (maybe). Remember, under Hong Kong’s linked exchange rate system, the HKMA is mandated to sell US dollars at HK$7.85 when necessary to protect the peg.
What stands behind the Hong Kong dollar? How much can they intervene until it breaks (Soros-British Pound style)?
The Hong Kong dollar is backed by the HK$4 trillion (US$513.5 billion) Exchange Fund, one of the world’s largest foreign exchange reserves. The fund, established as an asset war chest for defending the currency’s value, also makes investments, earning a record HK$252 billion in 2017 income.
So who is to blame for the HKD’s sudden demise? Simple – The Fed! (and HKMA gave you the answer in the previous paragraph)
As SCMP details, the main culprit behind the local currency’s slump is the carry trade, an arbitrage whereby investors borrow low-yielding currencies to buy high-yielding currencies.
This is an arbitrage, where traders take advantage of differences in prices, selling a low-yielding product (the Hong Kong dollar) to buy a high-yielding product (the US dollar). In this case, the price difference is between the local borrowing cost known as the Hong Kong interbank offered rate (Hibor) and the US borrowing cost known as the Libor.
Simply put, traders are borrowing against the low Hibor, selling the Hong Kong dollar to buy the US currency for investments in high-yielding US assets. The difference between the two is widest since 2008.
As more traders pile on to the carry, more pressure is placed on the Hong Kong dollar, causing it to weaken further against the US currency… and The Fed’s plan to hike rates (as many as four times) will do nothing to help ease the situation – meaning any dollars sold in defense of the weaker HKD will be battling global carry trade flows driven by The Fed’s tightening.
Howard Lee, deputy chief executive of the Hong Kong Monetary Authority, said on Tuesday that while the Hong Kong dollar had reached its weakest level in more than 30 years, this valuation was “well within the design of the system.”
“Since the global financial crisis, we have seen large amounts of funds flow into Hong Kong, and now we are seeing these same funds flow out,”
And in case you thought this was just something that geeky FX traders worry about, think again…
As SCMP reports, a leading Hong Kong chain store specialising in Japanese snacks and consumer goods has responded to the recent depreciation of the Hong Kong dollar by marking up its products by 3 to 5 per cent.
A strategy since put in place to minimise the impact of any exchange rate volatility had also backfired.
“After 2016 we tried to reduce the ratio of Japanese imports to about 30 per cent,” Lam said. “But the stores have lost their appeal for our loyal customers, most of whom are drawn to our line-up of Japanese snacks.”
One group of residents sensitive to a lower Hong Kong dollar would be the more than 300,000 foreign domestic helpers working in the city, who remit part of their wages back home every month.
But they should not worry as the value of the paper-money in their pockets evaporates… the central bank chief said “stay calm” remember!