(Yicai Global) April 13 -- The Hong Kong Monetary Authority, HKMA, has finally begun to intervene in the Hong Kong dollar market, with the currency hitting a record 33-year low.
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.
Under the Linked Exchange Rate System, LERS, HKMA will only buy the dollar from licensed banks at 7.75 and sell it when it triggers the weak-side CU of HKD7.85.
However, under the background of the continuous interest rate hikes by the Fed and the high Hong Kong dollar liquidity, the currency weakened against the dollar and approached the weak-side convertibility undertaking. “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.”
The exchange rate of the Hong Kong dollar against the greenback kept depreciating last year, and in late March it was extremely close to the weak side of 7.75-7.85 under the LERS, which is obscure for the market under the backdrop of the dollar’s depreciation.
“The key issue still lies in interest rates,” Zhou Hao, Commerzbank AG’s Asian senior economist, told Yicai Global, adding that the Hong Kong dollar’s interest rate remains low, which is the essential cause of its depreciation.
Traditionally, Hong Kong does not have an independent monetary policy and it achieves the purpose of linking the exchange rate to the dollar by following the US monetary policy. Therefore, as the Federal Reserve kicked off the rate hike cycle, the exchange rate of the Hong Kong dollar should have also risen theoretically. However, the actual situation is that the Hong Kong dollar interest rates have been falling since last year.
The 3-month London InterBank Offered Rate, LIBOR, rose to around 2 percent, while Hongkong InterBank Offered Rate, HIBOR, is still hovering at 1 percent. “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.”
The extremely ample liquidity is indeed a direct factor that has led to lower interest rates and weakened the Hong Kong dollar against the greenback. Continuous capital inflow began in Hong Kong from the second half year of 2014. Specifically, the base currency held by HKMA, amounting to approximately HKD1.2 trillion in mid-2014, surged to HKD1.6 trillion in early 2016, and the figure has recently approached HKD1.7 trillion.
Some analysts indicated that the rapid growth of the base currency indicates the inflow of funds into Hong Kong, a destination favored by mainland’s funds whether it is due to the optimistic view of the property market and the equity market or enterprises’ need to foray into overseas markets. Nevertheless, the increase in asset prices has failed to push up Hong Kong dollar interest rates, which is one of the reasons for the depreciation of the Hong Kong dollar.
Some traders also told the reporter that in the end, widening or maintaining a high level of spread signifies stronger motivation for interest arbitrage, like, to sell low-interest currency (the Hong Kong dollar) and hold high-interest currency (the dollar). Such mature trading method further worsened the devaluation of the Hong Kong dollar.
The HKMA has been waiting for the “market self-regulatory mechanism” to work and the Hong Kong dollar to automatically recover. However, the observant HKMA finally intervened by buying the Hong Kong dollar and selling the US dollar in the market to promote the Hong Kong dollar to rally.
Hong Kong’s Equity Market May Face Liquidity Pressure
HKMA’s buying the Hong Kong dollar means that there is an outflow of funds in the market. Hong Kong’s banking system can handle it as highly liquid assets among banks amount to HKD4 trillion, so both HKMA and banks are able to handle it, Lee said.
“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.
Lee also mentioned that the balance of funds in Hong Kong’s banking system is close to HKD180 billion, which is very high, and interest rates will rise gradually. Although the balance remains at a higher level, Hong Kong’s market will continue to tighten liquidity, Lee added.
HKMA’s intervention and further changes will lead the monetary base to fall quickly and HIBOR to rise sharply and weigh down the valuation of Hong Kong’s equity market, several market strategists told Yicai Global.
The focus now is to watch inflation trend in the US and changes in expectations on interest rate hike. If liquidity is expected to be tightened, it may lead the dollar-Hong Kong dollar spread to expand further and force the exchange rate drop to the weak-side convertibility undertaking at 7.85. It will also push HKMA to tighten liquidity.
Based on the past experience, analysts deemed that HK’s equity market may face pressure in pullback.
However, the equity market did not see big fluctuations in today’s trading sessions today.
Editor: Mevlut Katik