Hong Kong dollar’s travails point to global greenback supply problem
The Hong Kong dollar’s drift has already elicited a substantive response from the Hong Kong Monetary Authority
The recent weakening of the Hong Kong dollar against the US dollar may not be just a local event where markets have identified an opportunity to shift out of a lower yielding currency into a higher yielding one.
It could be an example of a broader trend of emerging US dollar scarcity that is pushing up the global price of borrowing dollars.
The Hong Kong dollar’s drift already elicited a substantive response on Thursday from the Hong Kong Monetary Authority (HKMA).
It said it is fully prepared to take appropriate action if the USD/HKD exchange rate reaches 7.85 allowing “the Hong Kong Monetary Base to contract gradually and create an environment conducive to the normalisation of HKD interest rates”.
That gradual contraction of Hong Kong’s monetary base, by elevating local borrowing costs, in the form of a higher Hong Kong interbank offered rate (HIBOR), would potentially erode the spread differential that has arisen in the US dollar’s favour as a consequence of the recent rise in the USD London interbank offered rate (USD LIBOR).
But it would not explain why USD LIBOR has risen in the first place and in truth the rise in US dollar borrowing costs isn’t just concentrating minds in Hong Kong.
It is also driving a widening spread of USD LIBOR over the USD Overnight Index Swap (OIS) rate, suggesting banks feel tighter credit conditions are in the offing.
While USD LIBOR reflects what various major banks estimate to be the interest rate they would have to pay to borrow dollars in the interbank market, the OIS is more reflective of the Federal Reserve’s own overnight fed funds rate.
It may be worth noting that 3-month US dollar LIBOR hit 2.09 per cent last week, its highest level since 2008, during the Global Financial Crisis.
Perhaps the higher USD LIBOR is being fuelled by market expectations of a faster pace of US rate rises than the Fed’s own forecasts are currently implying.
Last Friday’s strong US non-farm payrolls data could certainly support such a view. But perhaps there’s more to this than just interest rate rise expectations.
The USD LIBOR rise may also incorporate US dollar supply concerns as, just as with any commodity for which there is a permanent demand, prices rise if purchasers fear supplies will be scarcer.
And for the international banking system, the US dollar is a commodity. It is the oil that makes the global financial system run smoothly.
Within the US itself, onshore US dollar liquidity continues to be affected by the Federal Reserve’s ongoing quantitative tightening (QT) as it scales back its programme of asset purchases and seeks to shrink the size of its balance sheet.
QT of US$90 billion is scheduled for the second quarter of 2018, US$120 billion in the third and US$150 billion in the fourth.
Elsewhere, the US Treasury is now able to rebuild its own cash reserves held at the Fed following February 8’s Congressional approval of a federal budget that provides for a two-year funding deal.
Previously the US Treasury had to draw on its own deposits with the Federal Reserve to help the US government avoid debt ceiling breaches.
On February 8, the US Treasury’s closing balance in its deposit account with the Fed was US$202.6 billion. By March 8, it was US$251.6 billion.
Given that money just sits at the Fed, that is effectively US$49 billion removed from onshore US dollar liquidity in one month.
One consequence of the personal tax cuts inherent in December’s enacted US tax plan, meanwhile, is that the US Treasury is borrowing more money to cover the shortfall in received personal tax revenue. That is arguably helping push up the cost of borrowing dollars.
The US Mortgage Bankers Association reported last Wednesday that interest rates on 30-year fixed-rate US home loans had reached their highest level in four years.
Additionally, tax concessions encouraging the repatriation of US dollar profits currently held outside the United States must result in a diminution of the offshore US dollar liquidity pool as dollars are brought onshore. Offshore borrowers of dollars might rationally expect higher borrowing costs. USD LIBOR would rise as indeed it has.
The Federal Reserve seems relaxed about all this, its eyes still fixed on further gradual interest rates.
It is to be hoped the Fed’s apparent insouciance is well-grounded but there is a very real possibility that is not the case.
The Hong Kong dollar’s recent travails may be a symptom of a more fundamental global problem around higher US dollar borrowing costs.