The Hong Kong Monetary Authority (HKMA) recently stepped in to buy nearly 6.4 billion HKD to stabilize the city’s currency. The Hong Kong dollar (HKD) has been close to its lowest allowed limit against the U.S. dollar.

Historical Context

Since 1983, the HKD has been linked to the U.S. dollar through the Linked Exchange Rate System. This peg keeps the HKD around 7.80 per U.S. dollar, allowing it to trade between 7.75 and 7.85. The HKMA uses a Currency Board System, which means every HKD issued is backed by U.S. dollar reserves at a set rate. This system connects the monetary base to foreign exchange flows. When the HKD hits 7.75, the HKMA sells HKD to buy U.S. dollars, increasing liquidity. When the rate approaches 7.85, it buys HKD and sells U.S. dollars, reducing liquidity. This method helps keep the HKD stable within its trading range. The HKMA is again acting to protect the currency peg by buying Hong Kong dollars. Today, they purchased nearly 6.4 billion HKD to prevent the exchange rate from falling below the 7.85 limit against the U.S. dollar. This intervention responds to market pressures pushing the HKD close to its trading limit.

Pressure and Market Impact

The pressure on the HKD mainly comes from the interest rate difference between the U.S. and Hong Kong. The U.S. Federal Reserve is keeping rates steady at about 5.0%. In contrast, Hong Kong’s one-month interbank rate (HIBOR) is around 4.6%. Traders are borrowing HKD to invest in higher-yielding U.S. dollars, which pushes the local currency down. When the HKMA intervenes, it reduces liquidity in Hong Kong’s banking system. We saw a similar pattern in 2023, where repeated interventions caused HIBOR rates to rise sharply, narrowing the gap with U.S. rates. Derivative traders see this as a chance to invest in HIBOR futures, expecting these interventions will increase short-term borrowing costs soon. These tighter financial conditions can hurt the stock market. Higher borrowing costs impact corporate profits and may unsettle equity investors. This poses a risk for the Hang Seng Index, which has already dropped about 6% this past quarter. Buying put options on the Hang Seng Index or related ETFs may be a smart way to protect against the effects of defending the currency peg. While there is significant pressure, betting against the HKMA is often unwise, given their over US$415 billion in foreign reserves. A more cautious approach is to trade on the volatility of the USD/HKD pair. Traders can earn premium by selling out-of-the-money call and put options, confidently anticipating the HKMA will keep the currency within its 7.75-7.85 range. Create your live VT Markets account and start trading now.

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