Hong Kong is a Ticking Financial Time Bomb -- Can Hong Kong Dollar Peg Pop ?

Hong Kong’s foreign exchange market, usually the least interesting financial market in the world, has been making headlines recently. Hong Kong’s standing as a financial center rests partly on its decades long currency peg, in which officials tightly control the exchange rate against the U.S. dollar. But street protests, trade tensions and a looming recession have pressured the Hong Kong dollar, and some investors are preparing for a rupture. Economic indicators and other relevant evidence have signaled that the economic environment in Hong Kong has deteriorated significantly since June 2019. Hong Kong Monetary Authority is expecting a recession and a banking crisis.It will be interesting to see how long the Hong Kong Dollar - US Dollar peg can hold. Welcome to The Atlantis Report . Four months of anti-government protests have thrown Hong Kong into its deepest crisis in decades, pounding the financial hub’s economy and stock market and adding to its Sino-U.S. trade war woes. Since 1983, Hong Kong has pegged its currency to the U.S. dollar, helping make life more predictable for the city’s many trading houses and financial firms. The trade off is that this effectively forces Hong Kong to track U.S. interest rates even if, for example, tighter monetary policy might help cool local asset prices. Since 2005, the Hong Kong dollar has been allowed to trade at between 7.75 and 7.85 to the U.S. dollar. The Hong Kong Monetary Authority, the de facto central bank, buys U.S. dollars if the local currency is too strong, or sells them if it is too weak. It has intervened dozens of times since April 2018, spending a combined US$16 billion to support the Hong Kong dollar, including some that took place in March. As of Aug. 23, the Hong Kong dollar traded at 7.8425. Hong Kong’s monetary authority said it would cut the amount of capital that banks need to set aside, in the first reduction of the ratio since 2015 to release cash into the financial system to bolster it against any impact from political risks and the city’s unprecedented civic unrest. The city’s countercyclical capital buffer (CCB) will be reduced to 2 per cent effective immediately, from the previous 2.5 per cent, according to a statement by the Hong Kong Monetary Authority (HKMA). “Economic indicators and other relevant evidence have signaled that the economic environment in Hong Kong has deteriorated significantly since June 2019 . “Lowering the countercyclical capital buffer at this juncture will allow banks to be more supportive to the domestic economy and help mitigate the economic cycle.” The Hong Kong dollar is pegged in a narrow band around Hong Kong $7.8 per U.S. dollar, but has for weeks languished at the weak end as unrest has deepened, shedding 0.8% since early July. Bets in the market suggest some think the peg could falter. Can the Hong Kong dollar withstand the selling pressure? The entrepot city is facing its first recession in a decade, shaken by slowing Chinese growth, trade-war tensions and the increasingly violent protests. The forwards market suggests speculative bets on the peg breaking are building. Twelve-month forwards recently traded outside the currency’s range. Spreads in option markets have spiked to their widest in three years this month, in favor of dollar calls, suggesting investors are paying a high premium to bet on the Hong Kong dollar’s drop. Forward is telling you that some people expect the Hong Kong dollar to move out of the band . This was particularly unusual because it occurs while Hong Kong’s interbank borrowing costs are surging above U.S. dollar rates, something that would tend to support the currency by making it unattractive to short. IS THE PEG GOING TO POP? Probably not. The peg has proven resilient since it was conceived in 1983 to support the then-British territory’s currency against uncertainty over its handover to China. The Hong Kong Monetary Authority , the city’s de-facto central bank, buys local dollars if it gets too weak and sells to curb excessive strength. It has plenty of firepower, with $448.5 billion of assets in its foreign exchange fund alone as of July, representing roughly seven times the currency in circulation, according to HKMA. The peg has already survived every kind of speculative attack, including from famed short-seller George Soros during the 1997-98 Asian financial crisis, plus external shocks from the 2008 global financial crisis to China’s stock market plunge in 2015. “It always ends the same way – the Hong Kong Dollar peg stands tall and the speculators get burned. IS ANYTHING DIFFERENT THIS TIME? Yes. The situation is an unprecedented triple threat: A global slowdown, a trade war and domestic turmoil. Protests that began in opposition to a now-suspended extradition bill that would have allowed people to be sent to the mainland for trial - have swelled to include demands for greater democracy that are anathema to China’s leaders. Beijing has deployed paramilitary troops near the border with Hong Kong. “If mainland China police forces go into Hong Kong, then all bets are off,” since investors’ trust would be shattered . To be sure, it is a doomsday scenario the bank rates as unlikely. But anecdotally, investors are already scrambling to get money out, with property agents reporting spikes in interest from Hong Kongers in real estate in Malaysia, New Zealand and Australia. Moreover, China's yuan has also slumped to an 11-year low, weighing on emerging market currencies and the Hong Kong dollar.











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