The Hong Kong Monetary Authority (HKMA) purchased HK$9.4 billion (S$1.5 billion) of local currency. This came after the exchange rate touched the weak end of the permitted 7.75 to 7.85 per greenback trading band following a bout of intervention to rein in the currency’s gains.
In addition to pushing the currency back into its permitted trading range, the HKMA’s latest move will also make bearish bets more costly. It does this by draining liquidity from the financial system and driving up borrowing costs.
The intervention follows a roller-coaster ride for the Hong Kong dollar that has seen it swing between both ends of its trading range as authorities sought to protect the currency peg. The volatility has intensified debate about the sustainability of the fixed exchange rate, even though there are no signs that a change is imminent.
The HKMA is signalling that funding for carry trades is going to be more expensive and USD/HKD will not rise much further, said Rodrigo Catril, a currency strategist at National Australia Bank in Sydney. “For markets, the big question is: do you believe the peg will be protected? For now, authorities are showing that they are very much willing to defend it.”
When asked about the prospect of further intervention, the HKMA referred to its website, which says the monetary authority is committed to buying local dollars if the currency hits the weak end of the band.
The HKMA’s predicament stands in contrast to the dilemma faced by most other Asian central banks, which are trying to cool their currencies’ gains as the US dollar declines.
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It was just in early May when the Hong Kong dollar advanced to 7.75 per US dollar as the greenback weakened, prompting the HKMA to step in to check its gains. Authorities pumped in US$16.7 billion worth of local dollars into the financial system, driving it to the weaker end of the band.
The HKMA’s move to intervene at both ends of the trading range in the same year is “a first since the city’s de facto central bank reformed the peg system into a band in May 2005”, Stephen Chiu, chief Asia FX and rates strategist at Bloomberg Intelligence, wrote in a note.
“If the current, more frequent touching of the band becomes the new norm, reduced stability in the Hibor might not be constructive for businesses operating in the city, particularly the property sector,” Chiu wrote. “Subsequently, it may be natural for authorities to study whether the peg parameters should be modified – for example, the bandwidth and even the peg target.”
Hong Kong will maintain its currency’s peg to the US dollar as it is a key success factor, chief executive John Lee Ka-chiu told local media in early June, after a bout of volatility fuelled speculation about alternatives to a US dollar peg.
The latest intervention will reduce the city’s aggregate balance, a closely watched component of its monetary base and gauge of interbank liquidity to HK$164 billion, the HKMA said. Hong Kong also has US$431 billion in foreign currency reserves, according to the latest data for May.
Last month, the HKMA flooded the financial system with liquidity to rein in what had become a rapid appreciation of the local currency amid broad US dollar weakness. But that pushed borrowing costs lower and drove the spread between local interest rates and those in the US to a record.
When Hong Kong dollar’s funding costs are significantly lower than those in the greenback, traders tend to borrow the city’s currency and sell it against its higher-yielding US counterpart to earn the interest-rate difference. That’s made it the world’s most rewarding carry trade over the past month by one measure.
The gap between one-month rates in the US and Hong Kong was around 3.4 per cent this week. One-month Hibor was below 1 per cent before the HKMA intervention, not too far from a two-year low.
The currency traded around 7.8483 per US dollar in the morning session in Asia on Thursday. The local dollar’s slide in May was its biggest monthly slump since 1983 when it was pegged to the greenback. BLOOMBERG
