Hedge Fund Bets the Hong Kong Dollar’s ‘Tear’ Higher Can’t Last

(Bloomberg) -- The Hong Kong dollar’s recent strength could be tested soon, according to one hedge fund manager who is wagering against the pegged currency.

Hong Kong’s currency last week rose to its strongest level against the U.S. dollar since early 2017, fueled by a tightening liquidity environment. The rally comes just months after it touched the weak end of its allowed trading band, prompting the Hong Kong Monetary Authority to intervene and fueling speculation about the viability of the currency’s peg to the U.S. dollar.

In the eyes of Trium Capital’s Thomas Roderick, the Hong Kong dollar’s “tear” higher presented an attractive opportunity to short the currency via the options market. While recent initial public offerings have tightened liquidity and easing tensions within Hong Kong itself have boosted the currency, Roderick expects those tailwinds to fade. Meanwhile, the risk of protests reigniting within the city or the U.S. dollar catching a bid would weigh on the currency, he said.

“By mid-February, all of these things are going to be out of the way and I think the fundamentals will come back into play,” said London-based Roderick, a portfolio manager. “Given where we are, I’ve tactically gone long dollar here just because it makes sense.”

Hedge Fund Bets the Hong Kong Dollar’s ‘Tear’ Higher Can’t Last

The Hong Kong dollar is currently trading near 7.77 per dollar, after rallying to a three-year high of 7.7624 per dollar last week. Its trading band of 7.75 to 7.85 per dollar, set in 2005, has never been broken.

While Roderick expects the current liquidity squeeze to loosen, there are some signs it may persist a bit longer. The currency has remained strong past usual year-end cash demand, revealing a structural tightness, according to Morgan Stanley. Additionally, Hong Kong Exchanges & Clearing Ltd. is said to be discussing secondary listings with several Chinese technology companies, which could further zap liquidity.

Still, Hong Kong dollar watchers such as Australia & New Zealand Banking Group Ltd. and Credit Agricole CIB expect the rally to fade, citing seasonal cash crunches and the city’s weakening economic outlook.

Peg Debate

While the Hong Kong dollar is currently flirting with the stronger end of its allowed trading range, it tested the weaker end of the band multiple times in 2019. The episodes prompted hedge fund managers such as Hayman Capital Management’s Kyle Bass to wager on the eventual break of the peg, which dates back to 1983.

Roderick says that structural issues in Hong Kong’s monetary system, rather than a forced break, will prompt the city to abandon the peg. But his preferred way to express that view is to bet on higher Hong Kong interest rates versus those of the U.S. as any pressure on the peg will continue to force interest rates higher.

“The system was designed such that the peg doesn’t need to break but the thing that gives, the slack that tightens is the interest rates and if the interest rate goes too high, that raises all sorts of issues for the Hong Kong government,” he said.

Still, should the Hong Kong dollar return to 7.85 per greenback, the weakest end of its trading band, Roderick doesn’t plan to completely close his position.

“I’m always going to be skewed towards buying at the low end of that range,” Roderick said. “I would like to leave a bit on so I’ve still got some possible exposure to a peg break. This gives me both tactical and structural exposure.”

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