Hong Kong intervenes in market for the third time this year to defend currency peg amid capital flight
- The HKMA bought HK$7.1billion (US$905 million) on April 4 and sold the equivalent amount of US currency to protect the currency trading band
- Hong Kong banks did not follow the 25-basis point hike by the HKMA along side the Fed in March, triggering the carry trade and weakening the Hong Kong dollar
The Hong Kong Monetary Authority (HKMA) stepped into the foreign-exchange market for a third time this year to defend the local currency amid capital outflows.
The city’s de facto central bank bought HK$7.1 billion (US$905 million) in New York hours on Monday and sold the equivalent amount of US currency to keep the value of the local dollar within its trading band, after it weakened to HK$7.85 per dollar this week.
Hong Kong banks did not follow the 25-basis point hike by the HKMA along side the Federal Reserve on March 22, triggering the carry trade and weakening the Hong Kong dollar. Hong Kong pegged its currency to the US dollar in 1983 and in 2005 allowed its value to float within HK$7.75 and HK$7.85 in the open market under the city’s linked exchange rate system.
“Recent US inflation and employment data still present big challenges,” said Kenny Wen, head of investment strategy at KGI Asia in Hong Kong. The Fed’s hawkish tone has helped strengthen the US dollar, aiding carry trades in favour of higher-yielding US dollar assets, he added.
Traders were betting on a 50-basis point increase by the Fed at its March 22 policy meeting, after Fed chair Jerome Powell said on March 7 that policymakers could quicken rate increases as needed, and that the terminal rate would be eventually higher than expected.
Those bets were scaled back, with Goldman Sachs calling for a pause, amid a series of US bank failures while the turmoil surrounding Credit Suisse roiled global markets. The Fed eventually raised its key rate by a quarter point in March to a range of 4.75 per cent to 5 per cent.
Consumer prices rose at an annual rate of 6 per cent in February, versus 6.4 per cent in January. While the pace has slowed from a four-decade high of 9.1 per cent in June, it remains uncomfortably far above the Fed’s target of keeping it at 2 per cent or below.
The HKMA had earlier intervened twice in the currency market this year, when it bought a total of HK$19.09 billion in mid-February. It bought a total of HK$242.08 billion in 41 market interventions in 2022.
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The Fed’s rate lift-off since last year has widened the interest rate gap to about 140 basis points in favour of the US market, from near parity in November, based on one-month interbank rates, according to data compiled by the local monetary authority.
In carry trades, traders sell low-yielding products, the Hong Kong dollar in this case, to buy high-yielding US dollar assets to profit from the rate differentials. The selling of Hong Kong dollars drives its value to the weaker end of the trading band, typically forcing the HKMA to intervene.
The latest intervention will reduce the aggregate balance – the sum of balances in clearing accounts maintained by banks with the HKMA – by HK$7.1 billion to HK$69.92 billion on April 6, the HKMA said.
Hong Kong has the backing of one of the world’s largest financial war chests known as the Exchange Fund, which stood at HK$4.25 trillion on January 31.
