A Stunning Hong Kong Dollar Rally Is Quickly Unraveling

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(Bloomberg) -- A stunning rally in the Hong Kong dollar is unraveling quickly, with the currency briefly falling back to the weak half of its trading band.

The exchange rate dropped to as low as 7.8015 per greenback, past the midpoint of 7.8 in its allowed trading range. The pullback in the Hong Kong dollar followed a seven-day advance, which this week made the currency the most overbought in more than a year, according to its relative strength index.

A Stunning Hong Kong Dollar Rally Is Quickly Unraveling

The adjustment isn’t surprising as analysts thought the rally would prove short-lived. The ascent was mostly triggered by transitory factors, such as bets that liquidity will tighten toward year-end with banks hoarding funds for regulatory checks. Also, stronger risk appetite that’s been helping Hong Kong assets may not last, as the China-U.S. trade war is expected drag on next year. The currency jumped into the strong half of its band on Dec. 12.

But that doesn’t mean the Hong Kong dollar will fall all the way back to the bottom of the weak end. That’s because local interbank interest rates have stayed higher than funding costs in greenbacks since November, outstripping the income a trader can expect on U.S. dollars. Therefore, the short carry trade -- where investors sell the Hong Kong dollar and buy greenbacks -- won’t become popular anytime soon.

That short strategy repeatedly helped push the Hong Kong dollar to the weak end of the band, triggering official intervention. The city’s interbank liquidity pool shrank by 70% since April 2018 as the de-facto central bank bought back local dollars to defend the currency’s peg to the greenback.

As of 5:10 p.m. local time, the Hong Kong dollar weakened 0.06% to 7.7984. An indicator of the currency’s one-month interbank borrowing costs, known as Hibor, dropped for the first time in five days to 2.68%. The gap between the gauge and a similar measure of of rates on the greenback is close to the highest since 1999.

The Hong Kong dollar will fall to 7.82-7.83, as Hibor drifts lower as 2020 arrives, said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd.

©2019 Bloomberg L.P.

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