Why Hong Kong's Dull Dollar Has Investors Excited: QuickTake

(Bloomberg) -- Pegged to the U.S. dollar since 1983, most of the time the Hong Kong dollar is the dullest currency around. But this past year has been different: It has been falling and falling until in April it finally breached the point at which the central bank must intervene -- and it did, by purchasing the Hong Kong dollar. Sustained buying by the Hong Kong Monetary Authority would be eagerly watched by home owners and investors, since it might spell the end for the era of easy money that has helped drive housing prices and the stock market to record levels.

1. Why has the Hong Kong dollar been so weak? 

Primarily because the interest rates that matter in Hong Kong haven’t risen in tandem with U.S. rates, making it more attractive for investors to sell local dollars and buy higher-yielding U.S. dollars. The premium of the U.S. interbank rate, known as Libor, over Hong Kong’s equivalent, Hibor, has reached its widest point since 2008.

2. Why are interest rates stuck?

Simply put, an abundance of liquidity. As one of the main global financial hubs, Hong Kong has drawn massive inflows as a result of monetary easing by the world’s major central banks and an exodus of capital from mainland China. Investors there have been moving funds into markets including Hong Kong to diversify their portfolios. Those inflows mostly remain in Hong Kong, meaning banks are flush with cash. In such circumstances, there is no pressure for them to raise interest rates.

3. Why doesn’t Hong Kong mirror the Fed’s interest rate moves?

Every time the Federal Reserve lifts its benchmark interest rate, the HKMA does indeed raise its base rate -- but with little effect. That’s because the base rate is the rate at which the authority offers overnight funds to banks -- hardly relevant when the banking system is brimming with cash. The real rate to watch is Hibor: It’s the floating rate on most new mortgages and will be the first indicator of tightening liquidity. Another rate that matters is the prime rate, which is often the basis of a cap on mortgages. It is set by each of the banks; none of the major lenders has changed its prime rate since 2008.

4. When did the Hong Kong Monetary Authority intervene?

Hong Kong sets a range for its currency to trade in: $HK7.75 to HK$7.85 per U.S. dollar. For the first time since 2005, it breached the weaker end of the range on April 12. Later that day, the central bank bought the Hong Kong dollar, as it is mandated to, at the lower limit of HK$7.85. The HKMA has sold Hong Kong dollars from time to time in the past decade including after the global financial crisis. But the previous time it bought the currency was shortly before the new band was implemented in 2005, to curb inflows betting on a stronger Chinese yuan.

5. So is the currency under attack by speculators?

The current move to the weak end of the band has been well anticipated and has come without the fireworks associated with speculative attacks on pegged currencies. With record foreign-exchange reserves, the central bank is seen as having the capacity to comfortably shoot down speculators.

6. Why might this impact Hong Kong asset prices?

Central bank purchases of the currency have the potential to boost borrowing costs by draining liquidity from the financial system. Another option for the HKMA, which has a similar impact as buying Hong Kong dollars, is to sell a type of Hong Kong dollar debt known as Exchange Fund Bills. It last announced additional EFB sales in September, which helped to push up Hibor and stem currency declines. That also sucks liquidity from the system.

7. So when will Hong Kong rates finally, finally rise? 

Market indicators such as one-year forward points and interest-rate swaps tell the same tale: Expectations that rates will rise anytime soon are minimal. One measure of liquidity -- the city’s aggregate balance of interbank liquidity -- will stand at about HK$176.5 billion on April 16, according to the HKMA. Rates in Hong Kong won’t meaningfully increase until the balance falls below HK$50 billion, according to Ryan Lam, head of research at Shanghai Commercial Bank.

The Reference Shelf

  • There’s no reason to panic, says Bloomberg Gadfly’s Shuli Ren.
  • The HKMA’s background brief on the city’s exchange rate system.
  • Former HKMA chief executive Joseph Yam’s paper on the future of Hong Kong’s monetary system.
  • HKMA Chief Executive Norman Chan commented on the dollar peg in June.
  • A QuickTake on currency pegs and some more forex-related Q&As.

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