Hong Kong sells US$1.5 billion in three days to defend currency peg as traders seeking higher US yields spark capital outflows

The authority has spent a total of HK$11.697 billion (US$1.49 billion) in four interventions in the last three days
The Hong Kong dollar is likely to remain weak, forcing the HKMA to continue to intervene in the currency market in the coming months, say analysts

Banking & finance

Enoch Yiu

Published: 12:49pm, 13 May 2022

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Hong Kong’s de facto central bank stepped into the currency market again on Saturday morning as it sought to defend the local dollar against the weakening effects of capital outflow.

It was the fourth intervention in three days by the Hong Kong Monetary Authority (HKMA), bringing its total support for the currency to US$1.49 billion. The local dollar had fallen to its weakest level in more than three years.

The HKMA bought HK$3.164 billion (US$403 million) on Saturday morning to bolster the exchange rate and return the currency to its trading band, after it briefly fell to HK$7.8500 per US dollar. The band, in place since 2005, allows the Hong Kong dollar to fluctuate between HK$7.7500 and HK$7.8500 against the American currency.

The authority has bought a total of HK$11.697 billion and sold a combined US$1.49 billion in the four interventions, the first such action it has taken in 18 months.

“The weakening Hong Kong dollar followed capital outflow as the rising US interest rates recently led traders to sell the Hong Kong dollar and buy the US dollar to enjoy a higher interest rate,” said Robert Lee Wai-wang, the lawmaker for the financial services sector and chief executive of Grand Capital Holdings.

“The stock market downturn and the slump in initial public offerings in the first quarter also meant fewer overseas investors injecting capital into Hong Kong. The weak Hong Kong dollar is likely to continue, which will force the authority to continue to intervene in the currency market in the coming months.”

The interventions will reduce the aggregate balance – the sum of balances in clearing accounts maintained by banks with the monetary authority – to HK$325.894 billion on May 17, according to data provided by the HKMA.

Lee said the HKMA has more than enough to defend the peg. Hong Kong’s HK$4.5 trillion Exchange Fund is one of the world’s largest financial war chests to protect the local currency, which has been pegged against the US dollar since 1983.

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In past decades, the HKMA has used the Exchange Fund to buy or sell the Hong Kong dollar to make sure it is trading within the trading band. In a more drastic moment, the authority also used HK$118 billion from the fund to buy stocks in 1998 to fight against an attack by short sellers on the local currency.

“The recent capital outflow is only normal carry-trades in response to a widening interest rate gap between Hong Kong and the US. There is no sign of short sellers trying to attack the peg at the moment,” Lee said.

The capital outflow, and resulting interventions, will drive interest rates up. The three-month Hibor could reach 2 per cent by the end of this year, up from 0.83 per cent on Friday, according to Ryan Lam, head of research of Shanghai Commercial Bank.

This is the main culprit behind the Hong Kong dollar’s slump

“Liquidity will flow out of the banking system with HKMA’s intervention. Suffice to say, it is flipping almost overnight from monetary easing to tightening,” Lam said in a research note after the HKMA intervention. Rising rates “will certainly take some steam out of the economy, but hardly be the end of the world,” he said.

The HKMA’s most recent intervention came in October 2020, when it stepped in 85 times during the year, selling HK$383.5 billion of Hong Kong dollars to weaken the strengthening currency amid a flood of global capital that was chasing higher yields in Hong Kong amid low global interest rates.

The tide has turned since then, after the US Federal Reserve ended its era of low interest rates to temper inflationary pressure in the American economy. The US monetary authority flagged 10 increases in interest rates through the end of 2023, which has forced the HKMA to raise its rate in lockstep to maintain the city’s currency peg.

The HKMA’s most recent intervention at the weak end of the city currency’s trading band was in March 2019, when it spent HK$22.13 billion to buy a slumping Hong Kong dollar to bolster its exchange rate.