HK Dollar, The New Carry Trade

The HK dollar has been experiencing heavy selling even within its allowed trading band. So much so, the yuan has already appreciated past the value of the HK dollar and going further ahead on its own. Last year the yuan was still some 5% cheaper than the HK dollar. The HK currency is pegged to the US dollar. The economy was almost ruined in 1998-2000 when the island state management refused to devalue the HK dollar despite all other Asian currencies dropping like flies around them. That had the effect of pricing all goods & services in HK to be totally unsustainable and unfeasibly high. The secondary effect was that many industries had to be relocated out of HK to southern China in order to remain competitive. Even big HK listed firms had to outsourced as much of operations as possible NOT to be in HK in order to cut costs.

HK was lucky to recover as fast as it did, not so much because they did not devalue their currency but because of its proximity to China. Over the last 10 years China has stepped up to the plate and turned itself into the outsourcing capital of the world. Growing demand for professional services by Chinese mainland firms have jump-started many of the services sub industry of HK. Richer mainlanders visited and spent ferociously in HK. Without China, HK would have been in the doldrums still. The growth in listings of H-shares in HK have boosted financial services both ways. The surge of property prices and projects have given many in the sector something to diversify into during the down days.

The selling in HK dollar is largely prompted by the disparity between HK interest rates and US interest rates. There is a gap (HK rates lower), and since it is pegged fully to the US dollar: savvy investors are borrowing in HKD to invest elsewhere, or just park in USD deposits to lock in the gains. There is an additional chance that the HK Monetary Authority might repeg the HKD cheaper, so the HK carry trades would get a super boost should that happens as well.

The local currency hit a 22-year low last Wednesday, trading at 7.8256 to the US dollar. HKMA is not certain for now how the market would react if the Hong Kong dollar continues to fall, and the authority will have to intervene with the market, ensuring the currency is traded between the convertibility zone of 7.75 to 7.85 against the greenback. The danger is that the market forces will probably force HKMA's hand. Imagine big asset holders getting more jittery, they would sell assets to convert their HKD to other currencies, in particular the yuan (if can find a bank to do it). Market forces can swiftly turn itself into a whirlwind and when sellers in properties and stocks start doing the same thing, the HKMA has to step in immediately. Talking about it now will only bring forward the inevitable. The HKD has been overvalued for way too long.

Plus, if the HKMA were to repeg to say 8.2, this would be a short sighted move. HKMA will have to:

a) disband with the pure peg to USD altogether because its trade portfolio is not entirely USD important now

b) free float, while excellent, it will not happen, case closed

c) repeg but to a basket of currencies more closely linked to trade profile of HK, e.g. 25% yuan, 25% USD, 25% euro, 25% yen as a start

If the HKMA were to repeg to 8.2 or 8.3 but still with the USD, they will have to redo it again very soon and the peg is not a true reflection of underlying economy. A mismatch here bring problems to the underlying industries in HK and plays havoc with their competitiveness. Hence even in a repeg to the USD, it is best to also widen the allowed trading band. For example, if the repeg was to 8.2, at the same time announce that the peg would be allowed to trade with a 0.3 HKD band either way. That means effectively the peg can be 7.9 to 8.5. It gives HKMA more room to move and manage their financial economics better.

We have to appreciate that the HKMA MUST always put up a front that they won't devalue (even if they are thinking about it). Just the hint that they are thinking of a devaluation would sent aunties selling stocks and properties and converting them to AUD, Euro or Canadian dollars. Current BLR is at 8.0% or even 8.25%, not exactly comforting. That's partly why HK properties did not mirror the surges in Japan, Singapore or China big cities. At 8.0% plus a weakening outlook for HKD, properties won't be going anywhere.