Lessons From 1997 Show It's Scary Being a Hong Kong Dollar Bear

(Bloomberg) -- As the Hong Kong dollar sinks toward the weak end of its trading band, it’s worth looking back to 1997 for lessons of how the authorities may respond. What was back then a currency peg has since been replaced by a band, but that will not alter the determination of the Hong Kong Monetary Authority to defend it.

Although Hong Kong avoided the initial wave of currency attacks that began in July 1997 with the Thai baht’s devaluation, the city’s turn came in October. Excessive optimism in the Hang Seng Index quickly turned into panic selling and triggered a run on the currency. But the HKMA proved a brutal opponent for speculators to take on.

On the day that the fight reached a climax, overnight interest rates were allowed to climb to 300 percent as the HKMA held back from putting liquidity into the interbank market. This was enough to kill off the hedge fund attack as local banks could only raise funding for their own needs, so there were no Hong Kong dollars left to finance short sellers.

This time around it will be the first defense of the 7.85 level and the HKMA will need to rely on its currency reserves rather than a hard convertibility peg. Not that traders should expect any hesitation in the use of their full arsenal, worth more than $400 billion. And it’ll be combined with timely verbal intervention to remind investors that officials are on alert and fully engaged. Then there is China to consider.

Hong Kong’s money is Beijing’s money and the chance that Xi Jinping will sanction a devaluation of the Hong Kong dollar is very low. Currency swaps between central banks in Asia are being widely used, thus a line from the PBOC to backstop the HKMA would be completely normal. Access to China’s currency reserve pile is a very big stick to swing, even against today’s multi trillion dollar FX market.

The question for Hong Kong dollar speculators in 2018 is one that Clint Eastwood once used in a movie. So do you feel lucky?

(Mark Cranfield is a former currency trader who was working in Hong Kong in 1997, and is now a Markets Live blogger for Bloomberg. The observations he makes are his own and are not intended as investment advice. For more markets commentary, see the MLIV blog.)

©2018 Bloomberg L.P.