“Stay Calm” – Hong Kong Dollar Hits Peg Lower Band, 30 Year Low

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Remember, the chief of the Hong Kong Monetary Authority said “stay calm!”

The Hong Kong Dollar has been in free-fall for the last year (interrupted briefly in the middle of last year) but as its drop accelerated in recent days, HKMA wrote a blog to reassure the people that their paper-money is safe:

Stay calm on the weakening of the Hong Kong dollar

There have been concerns and discussions in the market about the recent weakening of the Hong Kong dollar (HKD).

Well Chan had better “get back to work” tonight as it’s Dollar-selling time as HKD breaks below the lower band of the peg for the first time since inception in 2005…

This is the weakest against the dollar in over 30 years…

What stands behind the Hong Kong dollar? How much can they intervene until it breaks (Soros-British Pound style)?

The Hong Kong dollar is backed by the HK$4 trillion (US$513.5 billion) Exchange Fund, one of the world’s largest foreign exchange reserves. The fund, established as an asset war chest for defending the currency’s value, also makes investments, earning a record HK$252 billion in 2017 income.

So who is to blame for the HKD’s sudden demise? Simple – The Fed! (and HKMA gave you the answer in the previous paragraph)

As SCMP details, the main culprit behind the local currency’s slump is the carry trade, an arbitrage whereby investors borrow low-yielding currencies to buy high-yielding currencies.

This is an arbitrage, where traders take advantage of differences in prices, selling a low-yielding product (the Hong Kong dollar) to buy a high-yielding product (the US dollar). In this case, the price difference is between the local borrowing cost known as the Hong Kong interbank offered rate (Hibor) and the US borrowing cost known as the Libor.

Simply put, traders are borrowing against the low Hibor, selling the Hong Kong dollar to buy the US currency for investments in high-yielding US assets. The difference between the two is widest since 2008.

As more traders pile on to the carry, more pressure is placed on the Hong Kong dollar, causing it to weaken further against the US currency… and The Fed’s plan to hike rates (as many as four times) will do nothing to help ease the situation – meaning any dollars sold in defense of the weaker HKD will be battling global carry trade flows driven by The Fed’s tightening.