For the 3rd day in a row, the Hong Kong Monetary Authority (HKMA) intervened in the FX markets and for the 3rd day in a row, failed to lift the Hong Kong Dollar off the lower limit of its peg band.
As Yicai Global reports, HKMA's weak-side convertibility undertaking of HKD7.85 against the dollar was triggered twice during London trading hours last night and New York trading hours this morning, HKMA Vice President Howard Lee disclosed during a meeting with the media today.
The HKMA conducted two foreign exchange transactions, buying the Hong Kong dollar and selling the greenback to the market. The total value of the transaction was HKD3.2 billion (USD407 million), reducing the balance of the banking system to HKD176.5 billion.
But for now, it's not working...
“Traders will not actually challenge the bottom line of the HKMA and we are dealing above that line,” a large-scale Chinese foreign exchange dealer told Yicai Global, saying that HKMA’s delay in intervention may have been designed for a market “pressure test.”
But, as we noted previously, The HKMA faces an uphill battle as money flows are against them in the global carry trade.
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.
“The sufficient liquidity of the Hong Kong dollar at present has resulted in the low HIBOR level,” Zhou Hao said. “With the Fed raising interest rates and unwinding the balance sheet, the spread will naturally put pressure on the Hong Kong dollar.”
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.
HKMA’s buying the Hong Kong dollar means that there is an outflow of funds in the market, which some fear may hurt Hong Kong's equity market...
“The market did not see a bigger outflow of funds in the near term, the balance of funds in the banking system reached HKD176.5 billion, and interest rates did not spike, but outflow of further funds and changes of interest rates should be closely monitored and there will be a higher external uncertainty in the second quarter of 2018,” an analyst of CCB International Holdings Ltd. told Yicai Global.
While market participants who have very short-term focus may have limited interest to sell HKD when HKD is already very close to the weak side of the band, in Goldman's view longer-term investors will remain a force driving HKD weaker. In particular, we continue to see large potential for some of the existing HKD time deposit and NCD holders to convert their savings to USD bank products in light of significant interest rate differentials (Exhibit 2).
As usual, though, any equity inflows induced by favorable stock market performance could be a counter-acting force and stall HKD depreciation.
In the previous round of HKMA intervention at the weak side (in 2004-2005), average liquidity drain was about HK$2.5bn per day on days when there was intervention, and there was seldom need for multiple consecutive days of intervention. The interbank market is much bigger now, so the pace of intervention and liquidity drain will probably be faster this time. But we believe the draining process will still likely be orderly.