Hong Kong's FX Move Spurs "Asymmetric" Rate Bet

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by Tyler Durden
Friday, May 13, 2022 - 01:39 AM

By Ye Xie, Bloomberg Markets Live commentator and reporter

This week has been dominated by the turmoil in the cryptocurrency world where Tether, the top stablecoin, is struggling to defend its peg to the dollar. In contrast, in the traditional-finance world, Hong Kong’s first currency intervention in three years seems rather more mundane.

As the peg-defending mechanism kicks in, Hong Kong’s borrowing costs rise to catch up with those in the US. Bank of America’s strategists see betting on a widening rate differential between the two as one way to profit from the Hong Kong Monetary Authority’s operation.

While Hong Kong’s move to defend the weaker end of its 7.75-7.85-per-dollar peg Wednesday – the first such move since 2019 - sounds like a big deal, it’s not. It’s how a currency peg is supposed to work. When the local dollar falls to the weaker end of the trading band, the HKMA steps in as the buyer of the last resort. Meanwhile, it drains liquidity in the banking system, boosting borrowing costs to attract demand for local dollars until the currency supply-demand balance restores.

Even if it’s routine, there are trading opportunities around. Bank of America’s strategists, for instance, see betting on higher local rates as an “asymmetric” play. The strategists, led by Chun Him Cheung, earlier this week recommended clients bet that the two-year Hong Kong swap rate will move higher relative to the U.S., targeting a move to 60 bps from 29 bps currently.

Under the currency peg system, Hong Kong’s monetary policy is tied to the U.S. When the U.S. raises rates, the HKMA needs to follow. Compared with the previous tightening cycle in 2018-2019, the HKMA may have to boost rates at a faster pace, because its aggregate balance, a measure of excess liquidity in the interbank system, is much larger. Meanwhile, a fair amount of Fed rate hikes has already been priced in, meaning that the Hong Kong rates have more room to play catch-up.

In addition, Hong Kong rates are also exposed to risks that can result in a spike, including the yuan weakness and potential financial sanctions stemming from U.S.-China tensions. Already, Hong Kong dollar volatility has started to move higher, like everywhere else. The currency volatility may well spill over to interest rates.