A Hong Kong Dollar at the Weak End Is No Reason to Panic

(Bloomberg Gadfly) -- It's time to face facts. Interest-rate arbitrage no longer works -- the Hong Kong dollar is being driven more by money flows from China.

The city's currency fell to HK$7.85 per dollar on Thursday -- the weak end of its permitted band for the first time since the range was imposed in 2005. The Hong Kong Monetary Authority said it stands ready to fulfill any requests from banks to buy at that level.

A Hong Kong Dollar at the Weak End Is No Reason to Panic

Hong Kong's currency has been on a steady decline since March, in part because of the rapid increase in Libor. A hawkish U.S. Federal Reserve and corporate tax cuts have sent 12-month Libor to 2.7 percent from less than 1.8 percent in September.

Arbitrage traders have been hard at work, narrowing the difference between one-year Libor and Hibor. The spread has shrunk to 0.69 percentage points from 1 percentage point in early March.

A Hong Kong Dollar at the Weak End Is No Reason to Panic

And yet the Hong Kong dollar keeps on weakening.

A reversal of money flows from the mainland is increasingly to blame. The constant tweeting by U.S. President Donald Trump about tariffs is denting sentiment. Over the past month, southbound buying through the city's two stock connects with Shanghai and Shenzhen has slowed substantially, recently flipping to net selling. The last time that happened was in August, and it also corresponded with a period of Hong Kong dollar weakness.

A Hong Kong Dollar at the Weak End Is No Reason to Panic

In a way, it isn't surprising. In emerging markets, central bank interest-rate policies often don't matter; weak currencies are a result of foreigners pulling money out.

But in theory, Hong Kong is a developed market.

You have to applaud the HKMA's grit. Last month, as the currency continued to slip, Chief Executive Officer Norman Chan said there were no immediate plans to sell additional Exchange Fund bills, even though the market had been expecting it to. Chan said that offering extra bills would be "solely in response to market demand for highly liquid instruments" and would have "nothing to do with the strengthening or weakening of the Hong Kong dollar."

The only role the agency should play, he said, was to act as a "super money changer," defending the peg only when the dollar touches either end of its range.

In a world of 24-hour news cycles, that's a responsible approach. Trying to manage domestic liquidity too actively can only fuel volatility and fan speculation on Hong Kong's commitment to the peg. Central bankers who try to do too much often end up unnerving the market. The HKMA's job is to be passive as long as the currency is within the peg.

Chan is no doubt well aware of the famously active retail investors in China, whose fast money can undo the work of interest-rate arbitrage traders. By standing firm behind the peg and setting clear goals, the HKMA is a beacon of good sense.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

To contact the author of this story: Shuli Ren in Hong Kong at sren38@bloomberg.net.

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