Hong Kong Dollar Strength Despite Domestic Issues

  • USD vs HKD rate hits upper limit of 7.75
  • HKD driven by Chinese invetment on the Hong Kong Stock Market
  • Hong Kong well poised to maintain peg

The Hong Kong Monetary Authority (HKMA) spent HK$7.7 billion (799.5 million British pounds) last week to defend its peg with the USD as the currency rose to its upper limit for the first time in more than four years. The peg has an ‘upper’ limit of 7.75, when USD is comparatively weaker and buys you less HKD and a ‘lower’ limit of 7.85 when USD is comparatively stronger.

Current USD to HKD rate: 7.8497 HKD

Current GBP to HKD rate: 8.3551 HKD

Current EUR to HKD rate: 7.4882 HKD

Forgetting the political turmoil and lockdown measures, analysts believe HKD is being driven by Chinese investment into comparatively cheap Hong Kong-listed stocks, favourable returns and the Hong Kong government’s spending plans.

The Hong Kong government is spending record sums in support of the economy which has crumbled under months-long protests in 2019 and a partial lockdown to fight the coronavirus.

HKD Rate Propped up by the Hong Kong Stock Market

The Hong Kong stock market is the third largest in Asia. 

IPO’s have locked up cash and kept interest rates elevated, according to Carie Li, economist at OCBC Wing Hang Bank. Chinese investors have poured cash into Hong Kong shares, many of which trade cheaper than peers on the mainland.

HKD – A Favoured Currency for a ‘Carry’ Trade

Traders will look to borrow in currencies which have lower interest rates in order to fund purchases in higher-yielding markets, such as Hong Kong currently. This creates a demand for HKD, greater inflows and thus a strengthening of currency.

As part of the peg arrangement, Hong Kong’s official “base rate” follows U.S. Federal Reserve policy. But once the Fed’s main rate loses its 50 basis points lead over the 5-day average of borrowing costs between Hong Kong’s banks – as it did in March – the HKMA’s policy tracks the local interbank rate. The Fed Funds Target Rate is at 0-0.25% and Hong Kong’s base rate was 1.19% on Monday, indicating a rich yield cushion for the Hong Kong dollar.

Could the HKD/USD Peg Crumble Moving Forwards?

Lebanon’s currency peg is currently cracking under economic pressure. A dollar shortage has seen the Lebanese pound tumbling from 1,500 to $1 – the official exchange rate peg since the late 90s – to about 3,000 to $1 on parallel markets by mid-April. 

But even if Hong Kong spent all the cash parked with the HKMA, it would still have enough foreign currency reserves to buy all the HKD 1.6 times over, said BNP’s Lo.

Hao Zhou, analyst at Commerzbank, also explained that the HKMA tends to be very prudent and has only spent $16 billion of its $437 billion FX reserves in 2018 and 2019 to defend the peg in times when HKD weakened. The Hong Kong government could even look to finance some of its own spending by selling foreign currency assets, if HKD cash reserves held with the HKMA run dry.

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