US tests tighter Hong Kong dollar peg
Last week, the Hong Kong Monetary Authority stepped in to support the local currency for the first time since 2019, highlighting the long-standing peg with the tightening US dollar. What are the banks saying?
Last week, the Hong Kong Monetary Authority (HKMA) spent about $1.5 billion to defend the local currency’s peg to the US dollar amid rapid monetary policy tightening by the Federal Reserve.
The HKMA made four interventions in three days to buy Hong Kong dollars, marking the first time it has entered the markets to buy the local currency since 2019.
Despite a war chest that has one of the largest financial reserves in the world, the demand for carry trades to sell the Hong Kong dollar is growing and local authorities are prioritizing growth over controlling inflation. What are the banks saying?
Carry Trade, Focus on Growth
A key driver of the Hong Kong dollar’s weakening has been the trend of carry trade – borrowing in Hong Kong dollars to buy higher-yielding US dollar assets – which has accelerated since February from this year, the Hong Kong Interbank Offered Rate (HIBOR) remaining well below the London rate. Interbank offered rate (LIBOR) during the month.
Additionally, Hong Kong rates are lagging due to a weaker growth outlook fueled by zero-Covid restrictions and capital outflows.
“Quantitative tightening and the fastest pace of interest rate hikes in the US since the pandemic have contributed to the widening spread differential between the two currencies, putting pressure on the HKD,” according to a note. Julius Baer research paper written by Head of Asia Fixed Income Research Madeleine Teo and Asia equity research analyst Richard Tang.
“The currency carry and the HKMA prioritizing growth over inflation should keep the HKD on the weaker side. »
As a result, increased pressure should be felt on the Hong Kong currency in the short term.
“We are only at the beginning of this cycle,” said William Deng, Economist for North Asia at UBS Global Research. “We believe the HKMA will likely proceed with more intervention to buy HKD in the coming months as the US Fed increases further.”
According to Deng, HKMA’s policy base rate and three-month HIBOR could reach 3% and 2.5%, respectively, by the end of 2022. This compares to the projection of an interest rate hike of 250 basis points by the Fed this year.
Nevertheless, the banks unanimously demand that the peg of the Hong Kong dollar – established in 1983 – remain resilient in the face of tightening US monetary policy.
“[Rising interest rates] will certainly slow down the economy, but it will certainly not be the end of the world”, according to a note of ryan lamhead of research at the Shanghai Commercial Bank, predicts the three-month HIBOR will hit 2% by the end of 2022.
At DBS, optimism was particularly strong regarding the improvement of liquidity conditions in the second half of the year with the anticipation of inflows of capital from Chinese listings.
“Hong Kong just has to complete this year,” said Samuel Tse, a Hong Kong-based economist at DBS. “I expect things to stabilize [the third quarter]. The stock market will recover, Chinese re-listings will bring in capital, and the money will come back. This will not be the end of abundant liquidity in Hong Kong. Not this time.”
Winds against the property
Still, a tighter US dollar will inevitably have a negative impact and there are fears that rising interest rates will hit Hong Kong’s infamously expensive property market.
“All else is equal, [an accelerated rise in the HIBOR] should benefit local banks in Hong Kong as their net interest margin may increase. On the other hand, the mortgage burden will increase, so we are monitoring whether this can possibly add pressure to the physical real estate market,” said Julius Baer.