Norman Chan Tak-lam, chief executive of the Hong Kong Monetary Authority, has warned of a potential US$130 billion of capital outflows due to expected US interest rate rises this year. Photo: Dickson Lee
White Collar
by Enoch Yiu
White Collar
by Enoch Yiu

Opinion: When the Hong Kong dollar weakens too much, bad things tend to happen

Interventions by the HKMA to defend the currency peg during a period of weakness for the Hong Kong dollar were accompanied by a sell-off in local stocks

The Hong Kong dollar is trading at a 14-month low against the US dollar, a threshold that in the past has led to capital outflows that wound up hitting the stock and property markets.

The Hong Kong dollar fell to 7.7849 against the greenback last week, which is the lowest level since February last year.

This is a hair away from the 7.8 level at which the Hong Kong Monetary Authority (HKMA) will start to intervene.

The weak Hong Kong dollar is related to a sharp rise in sterling and the euro. Sterling rose 3 per cent to a six-month high against the US dollar on April 20 after British Prime Minister Theresa May called a snap general election for June 8.

Then a few days later, the euro shot to a five-month high on indications pro-growth independent centrist Emmanuel Macron had taken the lead in the first round of voting in the French presidential election on April 23. He will now face off with Marine Le Pen on Sunday for the second and final round of voting.

Hong Kong $100 bank notes. Photo: Handout

Against major global currencies, both the US and Hong Kong dollar are weakening.

The HKMA will keep the Hong Kong dollar within the range of 7.75 to 7.85 before using part of its HK$3.5 trillion (US$450 billion) Exchange Fund to intervene. The Hong Kong dollar is pegged at HK$7.8 per US dollar.

Since 2009, the HKMA has intervened many times to prevent the currency from becoming too strong due to US monetary easing. An estimated US$237 billion in net capital inflows have entered Hong Kong since 2005, according to Daiwa.

Interventions to keep the Hong Kong dollar from exceeding the strong end of its trading band with the US dollar add up to a benign scenario for local asset prices.

But the situation is different when the authority defends the currency from weakening. In January last year, the HKMA stepped in to defend the currency from weakening too much. This came after the Hong Kong dollar fell to an eight-and-a half year low to 7.8924 per US dollar amid worries over capital outflows after US interest rates were lifted in December 2015.

The result was a sharp fall in the Hong Kong stock market.

The Hong Kong dollar then entered a period of relative stability, before rebounding in the second half of 2016 as the euro and pound retreated against the US dollar.

Fast forward to today and we find that the situation is once again changed. Major global currencies are rising against the US dollar. Hong Kong, which did not follow the Fed’s tightening moves in December and March, finds itself particularly vulnerable.

If the Hong Kong dollar weakens to 7.8 or below, the HKMA may need to intervene to help prop up the currency, potentially triggering a replay of the sharp fall of the stock market seen in January last year.

The intervention would also be accompanied by an interest rate rise in Hong Kong which would negatively impact mortgage borrowers.

HKMA chief executive Norman Chan has warned the city is facing up to US$130 billion of capital outflows due to expected US interest rate rises in the coming year.

A traditional market saying is to sell in May. That may prove wise advice this year. Watch the currency.

This article appeared in the South China Morning Post print edition as: Weak currency does not bode well for equities in the city