HKMA intervenes for a third day amid persistently weak currency
The Hong Kong Monetary Authority stepped into the foreign exchange market for a third day on Monday, bringing its purchases of Hong Kong dollars and total sales of US dollars to HK$13.26 billion (US$1.69 billion) amid a persistently weak local currency.
The de facto central bank spent HK$3.597 billion on Monday absorbing local currency funds to defend the Hong Kong dollar’s weak end of its trading band at 7.8500 against the greenback.
The HKMA’s intervention to absorb funds from the banking system signal a path to higher interest rates for the city, helping close the Hong Kong-US interest rate gap and end arbitrage trades that cause outflows from the city, analysts said.
“The size of Hong Kong dollar purchases by the HKMA suggests increasing selling pressure by investors as they scramble for the last chance to take advantage of the US -China rate differentials,” said Jasper Lo Cho-yan, senior vice-president at iBest Finance.
Foreign exchange traders have been actively selling Hong Kong dollars and buying the US currency in an arbitrage called the carry trade, which sells a low-yielding asset to buy another with higher returns, as they take advantage of the price difference between their borrowing costs.
The Hong Kong dollar continued to change hands at 7.8500 as of 7pm on Monday.
Hong Kong interest rates are detached from US rates because of massive liquidity parked in the city, especially under the Fed’s quantitative easing and yuan depreciation fears in 2015.
But Monday’s HKMA’s intervention is expected to bring the level of cash in the banking system, known as the aggregate balance, to HK$166 billion from HK$180 billion by settlement on April 18.
“At the current pace of interventions, the aggregate balance may drop to HK$100 billion by May, pointing to the prospect of higher Hibor rates and prime lending rates,” Lo said.
There are about a dozen interest rates in the city which indicate liquidity in different parts of the financial system or in the economy.
Reflecting gradually tightening conditions in the banking system, the three-month Hong Kong interbank offered rate or Hibor rose 4 basis points to 1.26 per cent. Interest rate swaps (IRS), derivatives used for hedging against future rate expectations, rose at an even faster pace. The one-year IRS jumped 12 basis points to 1.89 per cent and five-year IRS climbed 11 basis points to 2.61 per cent.
Analysts expect the combination of higher interest rates in the financial system would mean commercial banks also have to raise the important prime lending rate too, raising risks of piercing the city’s massive property bubble.
The prime lending rate has stayed unchanged at 5 per cent since 2008, and detached from rising US rates since the Fed began tightening in December 2016.
Philip Wee, FX strategist at DBS Bank, forecasts 3-month Hibor to rise to 1.65 per cent this quarter from 1.21 per cent.