Macroscope | Why betting against the Hong Kong dollar peg is a fool’s errand

In financial markets, there are some loss-making trades that investors rue more than others. One of the most talked-about ones is betting against Japanese government bonds, which has been known as the “widow-maker”. There are others that at one point appeared to be paying off but ultimately failed, such as wagers on the break-up of the euro zone.

Another trade that has proved ruinous over the years but still has its proponents is betting against the Hong Kong dollar. Its nearly 40-year-old peg to its US counterpart has withstood repeated attacks by speculators, notably by financier George Soros during the 1997-98 Asian financial crisis.

Hong Kong’s currency board, which requires the city to import monetary policy from the United States, is once again under scrutiny. This year’s dramatic rise in interest rates in the US – which has forced Hong Kong’s de facto central bank to follow suit and intervene heavily to stop the local currency falling beyond the weak end of its permitted trading band – has accentuated the divergence in economic cycles between the city and the US.

The peg’s critics have seized on the sharp fall in the aggregate balance, a gauge of interbank liquidity. In the past two months, it has halved to HK$165 billion (US$21 billion) because of the Hong Kong Monetary Authority’s purchase of HK$172 billion since May 11 to shore up the currency.

Pressure on the Hong Kong dollar is attributable to “carry trade” behaviour. Sufficient liquidity has prevented local interbank rates from rising to fully match their US equivalents. This has made it attractive for traders to borrow in Hong Kong dollars to put money into the higher-yielding US dollar and pocket the difference.