Ebb in yuan speculation lets dollar reclaim its peg position
Arbitrage trading has finally pushed the local dollar back to its greenback peg rate, forcing the Hong Kong Monetary Authority (HKMA) to buy Hong Kong dollars in the market for the first time in almost five months.
The move late on Monday came as recent speculation about a near-term revaluation of the yuan tapered off, opening the door to another wave of general US dollar strengthening.
Locally, market participants were also trying to take advantage of the interest-rate differential between short-term rates in the United States and Hong Kong, which is expected to widen further from about 2 per cent once the US Federal Reserve - as is widely anticipated - raises its target rate later today.
'If the gap between US and local rates widens [this week], funds may flow out but that is a normal phenomenon,' Joseph Yam Chi-kwong, head of the HKMA, said yesterday.
Over the past year, Mr Yam has repeatedly pointed out that the higher returns on US dollars make it logical for local banks and traders to shift their assets into the greenback. However, they have been unwilling to do so amid concern that a possible revaluation of the yuan, or mere speculation thereof, could prompt another spike in the Hong Kong dollar.
This has been particularly noticeable in one-year Hong Kong dollar forwards, where the discount has remained wide even at times when the spot rate has returned to the $7.80 peg rate. Yesterday, the discount narrowed by just over 100 pips to 1,155 pips, which still indicates the Hong Kong dollar will appreciate to $7.68 in 12 months.
Short-term Hong Kong interbank offered rates (Hibor) started to edge higher on Monday, amid a belief there would be capital outflows, and shot up further yesterday after the HKMA bought $3.82 billion in exchange for US dollars in offshore trading. The purchase will reduce the liquidity in the local banking system by the same amount to $11.97 billion, which will add more upward pressure on market rates.
That, analysts say, is the first step towards a 'normal' situation, in which local banks will raise deposit and savings rates in tandem with the US Federal Reserve.
In the current cycle, the large amount of liquidity in the banking system - also known as the aggregate balance - has allowed Hong Kong rates to remain steady even as US rates have headed higher. Local banks have followed only one of the five Fed rises since last June, and even then, the size was only half that of the Fed. Six weeks later, the move was reversed after renewed inflows restored liquidity to the system.
HSBC general manager Raymond Or Ching-fai said yesterday the chances of Hong Kong banks copying the widely expected 25 basis point interest rate rise by the Fed were very slim because of the excess amount of cash in the system.
'When the aggregate balance falls to $100 million to $200 million, then the banks will need to follow,' he said.
Some market participants said it may happen earlier than that, however, and noted that when the banks last raised prime lending rates, last September, the aggregate balance stood at $3.2 billion.
However, the performance of short-term market rates will be key for the timing, they argued.
'I think they will need to monitor the overnight performance for overnight interest rates and make sure they are staying above a certain level, say 0.5 per cent, for three to four weeks before they go ahead and increase the savings and deposit rates as well,' said Tommy Ong, vice-president of treasury and markets at DBS Bank.
Overnight Hibor rose marginally to 0.14 per cent after the HKMA came into the market from 0.13 per cent on Monday.
The three-month rate increased to 1.12 per cent from 0.81 per cent but still trades 163 basis points below its US counterpart.
A further decline in the aggregate balance is on the cards in the near term, according to market participants, who project traders will be very keen to cover their short US dollar positions before the Hong Kong market closes down for the three-day Lunar New Year holiday.
'That's an uncertainty traders don't like,' said Leo Au, chief foreign exchange dealer at Commonwealth Bank of Australia, noting that there was always the risk that the US dollar could strengthen rapidly for whatever reason while the local market was closed and put pressure on the Hong Kong dollar.
The US dollar could receive another short-term boost if the Fed rate rise, and the accompanying policy statement, finally triggered a rise in 10-year US bond yields, argued James McCormick, global head of foreign exchange and emerging markets research at Lehman Brothers.
But in the longer term, the US dollar was bound to fall further, he said, projecting that this year would see a significant rally in Asian currencies while the greenback was in for its fourth straight year of declines.
