Battle to defend Hong Kong dollar peg not over with more HKMA intervention seen in fourth quarter

Defending peg has cost HK$147b this year with the latest interventions triggered by investors switching out of yuan deposits after devaluation

PUBLISHED : Tuesday, 06 October, 2015, 8:15pm
UPDATED : Tuesday, 06 October, 2015, 10:59pm

The Hong Kong Monetary Authority is tipped to continue its market intervention to defend the Hong Kong dollar peg in the fourth quarter while the city's defacto central bank is also expected to struggle with lower Exchange Fund investment returns in the same time frame.

The HKMA this year has spent HK$147.29 billion to defend the peg, including 13 interventions from September 4 until last Friday that cost HK$75.79 billion in an attempt to weaken the local dollar.

The latest round of interventions were triggered by investors switching out of yuan deposits or other investments back to the Hong Kong dollar, prompted by the 3 per cent devaluation in the yuan in August. These conversions pushed the Hong Kong dollar to 7.75 - the high end of its peg to the greenback - triggering the HKMA to dip into its HK$3.27 trillion Exchange Fund to defend the link. The HKMA will intervene in the market whenever the currency is trading beyond the range of 7.75 to 7.85.

"It is likely the HKMA will have to do more intervention to defend the peg until the end of this year because yuan devaluation is likely to continue in the fourth quarter together with the weak China economy," said Jasper Lo Cho-yan, a director of Tung Shing Futures.

"The trend for yuan conversion back to Hong Kong dollars will continue.

"A strong Hong Kong dollar is likely to continue and the HKMA will need to continue its battle to weaken the currency to defend the peg," Lo said.

The previous round of HKMA interventions came in April but for different reasons. The authority intervened 12 times between April 9-27, spending HK$71.49 billion to weaken the Hong Kong dollar that had spiked during a stock market rally. Hot money flowing into the stock market saw the Hang Seng Index hit a seven year high, tripling the average daily market turnover to HK$200 billion in April.

The HK$147.29 billion spent to defend the peg this year has easily bypassed last year's HK$75.3 billion intervention and the HK$110 billion spent in 2012 - both also triggered by hot money inflows.

However, the record high intervention remains the 16-month period from September 2008 to December 2009 when the HKMA sold more than HK$620 billion to weaken the local dollar after large amounts of hot money flowed into the Hong Kong stock and property markets when the US began its monetary easing policy after the global financial crisis

"Compared to previous episodes, the current intervention amount is still small and manageable. Once mainland risk sentiment stabilises and the capital inflows to Hong Kong subside, USD/HKD can be expected to rebound from 7.75," said Heng Koon-how, senior foreign exchange strategist at Credit Suisse private banking.

Joseph Tong Tang, executive director of Sun Hung Kai Financial, said the HKMA would not only need to continue its battle to defend the peg in the fourth quarter but he believes the authority will also struggle with the Exchange Fund investment performance.

"After a very volatile third quarter, global investment markets would still be rather volatile during the fourth quarter," Tong said. "It will be hard for the Exchange Fund to achieve a good return."

HKMA chief executive Norman Chan Tak-lam last month said he was not "optimistic" regarding the fund's performance this year given the "challenging" markets.

"This year is challenging for investment markets. We would not be optimistic to the Exchange Fund investment performance this year" Chan said.

The Exchange Fund in the first half of this year reported a 64 per cent year-on-year drop in net investment income to HK$20.4 billion, down from HK$56.4 billion last year.

The poor result was due to foreign exchange valuation losses and bond investments but that was offset by a strong performance in its Hong Kong stock portfolio in the first half when the Hang Seng Index hit a seven year high in the April before slumping in July.

The local reserve's stock investment return stood at HK$18.8 billion in the first half, up 889 per cent year on year. The market rout in summer is likely to hurt stock investments in the third quarter given that the Hang Seng Index has dropped 20.6 per cent, its worst quarter since 2011. The Exchange Fund will report its third quarter result at the end of October.