Carry trade returns as interest rate gap drives Hong Kong’s dollar to the weak end of its peg

The local exchange rate is one of the worst performers worldwide in the past two months with a 0.74 per cent drop against the US dollar, and last traded at HK$7.8464

Depreciating past HK$7.8500 will prompt intervention by the city’s de facto central bank

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A billboard showing Hong Kong’s HK$100 banknote design at the HSBC Building in Central on 2 January 2023. Photo: Jonathan Wong

Published: 10:35am, 6 Feb 2023

The Hong Kong dollar is rapidly heading toward the weak end of its trading band against the greenback as traders sell the currency to buy higher-yielding US assets.

The local exchange rate is one of the worst performers worldwide in the past two months with a 0.74 per cent drop against the US dollar, and last traded at HK$7.8464. Depreciating past HK$7.8500 will prompt intervention by the city’s de facto central bank.

The currency weakness is being fuelled by a plunge in the local cost of borrowing, which decreases the appeal of owning the Hong Kong dollar versus its US peer. One-month interbank funding costs for the currency, known as Hibor, have dropped to 2.4 per cent from a peak of 5.08 per cent in early December. Comparable rates on the greenback, or Libor, are 4.57 per cent, resulting in the widest spread since 2007. The gap makes shorting the Hong Kong dollar profitable in a revival of the carry trade.

The slump in the currency may reopen the debate over its future. Bill Ackman said in late November he is betting big on a collapse of the Hong Kong dollar, a trade supported by hedge fund manager Boaz Weinstein, founder of Saba Capital Management.

Liquidity is plentiful right now amid capital inflows and still weak demand for loans. Money has been pouring back in as investors bet on a recovery in China after the nation’s pivot away from zero-Covid, with the benchmark Hang Seng Index surging almost 50 per cent since the end of October.

Yet economic activity remains depressed. The city’s gross domestic product shrank 3.5 per cent last year, its third contraction in four years, while home prices plunged about 16 per cent. The Hong Kong dollar loan-to-deposit ratio dropped to 88.4 per cent at the end of December from 89.6 per cent at the end of November, as deposits in the currency increased and loans fell, according to the Hong Kong Monetary Authority (HKMA).