Hong Kong’s crowded currency trade enters perilous territory

One of the world’s most reliable currency bets is suddenly looking like less of a sure thing.

The Hong Kong dollar carry trade, which has produced steady returns for seven straight months, suffered a rare setback on Wednesday as the currency abruptly strengthened the most since February 2016. Its 0.1 per cent gain against the U.S. dollar may have been tiny by global standards, but it jolted investors who had positioned for declines by borrowing in Hong Kong to invest in higher-yielding American assets.

The trade had been a consistent winner this year after interest rates in the U.S. rose and those in the former British colony held near rock-bottom levels. But now the tightly managed exchange rate is turning more volatile as it approaches the weak end of a trading band imposed by the city’s de facto central bank.

The Hong Kong Monetary Authority (HKMA) triggered Wednesday’s spike by announcing plans to sell additional debt instruments called Exchange Fund Bills. While the HKMA said its decision had nothing to do with the currency, some traders speculated that the move was designed in part to drain cash from the financial system and guide local interest rates higher.

That would help support the Hong Kong dollar before the HKMA is obliged to defend the currency at HK$7.85 versus the greenback -- something it hasn’t had to do since the current trading band was implemented in 2005.

“The long carry trade -- long U.S. dollar against Hong Kong dollar -- has been one of the easiest trades this year and it’s probably a little crowded as well,” said Gary Yau, a strategist at Credit Agricole CIB in Hong Kong. “As the spot is near unprecedented territory, there is a lot of uncertainty and views by different parties in the market, which is why you get such sharp moves and more volatility than usual.”