HONG KONG (Reuters) – The Hong Kong Monetary Authority said on Thursday it had no immediate plans to issue bills to prop up the local dollar until it hit the limits of its trading band but warned that it had sufficient firepower to defend the currency.
The authority, which is the city state’s de facto central bank, also urged calm after the currency fell to 33-year lows.
The Hong Kong dollar HKD=D3 traded as low as 7.8425 to the U.S. dollar, its lowest level since 1984. The move took it closer to the lower end of a trading band that has been in place since October 1983.
Under this system, Hong Kong’s monetary policy tracks that of the U.S. Federal Reserve and authorities allow the currency to trade in a band of 7.75-7.85 per dollar. But in recent months, investors have increased bets against the currency, as the interest rate gap with the United States has widened.
The HKMA had remained silent despite the Hong Kong dollar’s sharp weakening in recent days, prompting speculation that it was not standing in the way of currency weakness.
During past episodes of weakness, the HKMA has tended to issue additional exchange fund bills to soak up excess cash in money markets, putting a floor under interbank rates and the currency.
While local money market interest rates broadly follow U.S. counterparts, they have diverged noticeably in recent months as the United States raises interest rates while Hong Kong remains awash in ample money market liquidity, thanks to inflows from Chinese investors and overseas into its domestic markets.
WAITING FOR THE HKMA
The gap between three-month U.S. money market rates and the Hong Kong equivalent has soared to more than 100 basis points from 30 basis points in late November, fuelling demand from speculators who want to take advantage.
The HK dollar has subsequently weakened – also hurt by worries over how a global trade war could impact Hong Kong’s small, open economy – and expectations have grown that the Monetary Authority would step in to stem the slide.
But on Thursday, HKMA chief executive Norman Chan ruled out interventions until the currency hit the lower end of the trading band at 7.85 per dollar.
“We do not have plans to issue additional Exchange Fund bills for the time being and hope that market players will not take it wrongly that the HKMA does not want the HKD to weaken,” Chan said in a column published on the central bank’s website.
“In fact, with the widening of the spreads between HKD and USD interest rates, we are looking forward to funds flowing from the HKD into the USD, causing the HKD exchange rate to reach 7.85, a level where the HKMA will take action.”
He added that the HKMA’s issuance of additional Exchange Fund bills last time had been solely in response to market demand for highly liquid instruments and “had nothing to do with the strengthening or weakening of the HKD”.
But in a sign that overall conditions remained broadly calm, currency forward points were broadly calm, indicating that investors expected conditions to return to normal soon.
(GRAPHIC: Hong Kong dollar falls to 33-year lows – reut.rs/2FqTGuQ)
PLENTY OF AMMUNITION
Hong Kong’s pegged currency system, one of the last in the world, has come under frequent speculative attacks by global hedge funds who have bet the city would abandon its link to the U.S. dollar as it strengthened links with China.
Its most serious challenge came after the Asian financial crisis in 1997-98, and the most recent high-profile attack was in 2011, when Bill Ackman, CEO of Pershing Square Capital Management, bet heavily against the peg.
But Hong Kong has over $400 billion in reserves, which should be enough to see off any speculative challenge.
“Some people are getting excited about a potential peg break scenario but the HKMA has plenty of ammunition to fend off any challenge,” said Timothy Graf, head of macro strategy at State Street Global Markets in London.
In another sign that hedge funds are broadly quiet on the peg, risk reversals on the Hong Kong dollar, a ratio of puts to calls, remained far below levels seen during China’s mid-2015 stock market crash HKD3MRR=.
In a note this week, JP Morgan saw little economic reason for the Hong Kong dollar to weaken much. It noted the city had the biggest net international investment-to-GDP ratio, at 390 percent – a measure of its external strength – and a current account surplus of 4 percent of GDP.
The HKMA noted that about $1 trillion Hong Kong dollars ($130 billion) has flowed into the city since the U.S. introduced quantitative easing in 2009, and said those funds were ready to be deployed.
“The HKMA can therefore act as as a ‘super money changer’ to meet the conversion demand arising from any significant fund outflows in extreme circumstances,” it said.
($1 = 7.8386 Hong Kong dollars)