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Hong Kong is burning through aggregate balance defending dollar peg
Hong Kong is burning through a closely watched component of its monetary base to ward off attacks on its dollar to little avail, with the lack of reaction in money markets likely to keep the pressure on the beleaguered currency.
The city’s aggregate balance — a gauge of interbank liquidity — has halved this year without driving local borrowing costs higher, the traditional mechanism for reversing weakness in the Hong Kong dollar.
While the currency is pegged to the US dollar, the city’s one-month rates still trail their American counterparts by some 170 basis points, setting up a sweet spot for so-called carry traders.
It remains profitable for the traders to borrow the Hong Kong dollar cheaply and buy the higher-yielding greenback, pocketing the rate difference. The trades are likely to keep pushing the currency to the weak end of its fixed band against the US dollar and force policymakers to drain even more liquidity from the system.
The local currency traded at 7.8497 per US dollar on Friday — it is pegged between 7.75 and 7.85.
A hawkish Federal Reserve and the rise in US interest rates account for some of the abnormality, with muted demand for Hong Kong dollars in the city playing a role. Banks are seeing shrinking demand for loans amid sluggish economic growth and the number of new stock listings has fallen off a cliff.
Some speculate the aggregate balance may fall toward zero from about HK$49 billion (US$6.2 billion) today, leaving the Hong Kong Monetary Authority turning to other options to defend the currency peg. While it has about US$430 billion in foreign reserves, Hong Kong’s link to the dollar is under constant scrutiny with prominent hedge funds betting it will break and some strategists arguing for a shift to a yuan peg.
“Such thin Hong Kong dollar liquidity buffer flags higher risk of a liquidity squeeze, in the event of a sudden surge in the demand of the currency or a contraction in supply,” said Ken Cheung, chief Asian foreign exchange strategist at Mizuho Bank.
While the aggregate balance has fallen toward zero before, it’s rare for the gap between Hong Kong and US rates to be so wide amid such thin liquidity. When the pool was at similar levels in 2019, the spread between the two rates narrowed sharply and reversed. And during the financial crisis in 2008, when the balance was close to zero, the rate spread also flipped.
Hong Kong loan growth contracted for a ninth straight month in February, the longest streak since 2009, according to official data. In the stock market, just US$1.64 billion has been raised through new listings this year, the lowest in a decade, data compiled by Bloomberg show.
Still, most analysts expect Hibor to rise before the end of June and dividend payout season in the summer.
“Banks need at least some liquidity left in the aggregate balance for daily settlement purposes,” said Kelvin Lau, a senior economist at Standard Chartered Bank. “So before the aggregate balance can ever reach zero, Hibor would have gone up evidently to reflect tightened liquidity conditions.”
While the currency is pegged to the US dollar, the city’s one-month rates still trail their American counterparts by some 170 basis points, setting up a sweet spot for so-called carry traders.
It remains profitable for the traders to borrow the Hong Kong dollar cheaply and buy the higher-yielding greenback, pocketing the rate difference. The trades are likely to keep pushing the currency to the weak end of its fixed band against the US dollar and force policymakers to drain even more liquidity from the system.
The local currency traded at 7.8497 per US dollar on Friday — it is pegged between 7.75 and 7.85.
A hawkish Federal Reserve and the rise in US interest rates account for some of the abnormality, with muted demand for Hong Kong dollars in the city playing a role. Banks are seeing shrinking demand for loans amid sluggish economic growth and the number of new stock listings has fallen off a cliff.
Some speculate the aggregate balance may fall toward zero from about HK$49 billion (US$6.2 billion) today, leaving the Hong Kong Monetary Authority turning to other options to defend the currency peg. While it has about US$430 billion in foreign reserves, Hong Kong’s link to the dollar is under constant scrutiny with prominent hedge funds betting it will break and some strategists arguing for a shift to a yuan peg.
“Such thin Hong Kong dollar liquidity buffer flags higher risk of a liquidity squeeze, in the event of a sudden surge in the demand of the currency or a contraction in supply,” said Ken Cheung, chief Asian foreign exchange strategist at Mizuho Bank.
While the aggregate balance has fallen toward zero before, it’s rare for the gap between Hong Kong and US rates to be so wide amid such thin liquidity. When the pool was at similar levels in 2019, the spread between the two rates narrowed sharply and reversed. And during the financial crisis in 2008, when the balance was close to zero, the rate spread also flipped.
Hong Kong loan growth contracted for a ninth straight month in February, the longest streak since 2009, according to official data. In the stock market, just US$1.64 billion has been raised through new listings this year, the lowest in a decade, data compiled by Bloomberg show.
Still, most analysts expect Hibor to rise before the end of June and dividend payout season in the summer.
“Banks need at least some liquidity left in the aggregate balance for daily settlement purposes,” said Kelvin Lau, a senior economist at Standard Chartered Bank. “So before the aggregate balance can ever reach zero, Hibor would have gone up evidently to reflect tightened liquidity conditions.”
