The Hong Kong Monetary Authority (HKMA) recently stepped into the foreign exchange market by selling U.S. dollars to support the Hong Kong dollar (HKD). The HKD is currently near the weak end of its trading band, close to the USD/HKD limit. Since 1983, the HKD has been linked to the U.S. dollar through the Linked Exchange Rate System, keeping it around 7.80 per U.S. dollar. The system allows for a trading range of 7.75 to 7.85 to promote stability in exchange rates.

Currency Board System

The HKMA uses a Currency Board System. This means every HKD issued has U.S. dollar reserves backing it. This approach directly connects changes in the monetary base to foreign exchange inflows and outflows. There is also an Intervention Mechanism. If the HKD approaches the strong side of 7.75, the HKMA sells HKD and buys U.S. dollars, adding liquidity. Conversely, if the HKD nears the weak side of 7.85, the HKMA buys HKD and sells U.S. dollars, decreasing liquidity. This helps keep the HKD within its limit. Currently, the HKD is again close to the weak end of its trading band at 7.85 against the U.S. dollar. This has prompted the HKMA to buy Hong Kong dollars, tightening local financial conditions. The central bank’s dedication to maintaining the peg is clear. This intervention reduces cash in the city’s banking system, causing interest rates to rise to attract more capital. The 1-month HIBOR (Hong Kong Interbank Offered Rate) has climbed to 5.75% in early August 2025, its highest level this year, due to ongoing capital outflows linked to uncertainties in mainland China. While the HKMA is defending the peg, we expect upward pressure on rates to continue.

Opportunities For Derivative Traders

For traders focused on derivatives, anticipating higher Hong Kong interest rates in the coming weeks could be a smart move. This can be achieved by buying HIBOR futures or entering interest rate swaps that pay a fixed rate. This strategy plays off the effect of the HKMA defending the currency peg. We witnessed this situation repeatedly in 2022 and 2023 during the last major rate increase cycle by the U.S. Federal Reserve. In those years, the HKMA’s actions consistently led to sharp increases in HIBOR. What we see now is simply a continuation of that established pattern. Rising borrowing costs in Hong Kong send a negative signal to the equity market. The Hang Seng Index has struggled this quarter, and tighter liquidity will likely add pressure on corporate earnings and property values. Since late July 2025, the index has already dropped 4%. This indicates a cautious or bearish outlook for Hong Kong stocks. Traders might consider buying put options on the Hang Seng Index or shorting index futures to hedge against or profit from a potential decline. These positions will increase in value if tightening financial conditions continue to impact the market. While the currency is at the edge of its band, betting on a break of the peg is not advisable. The HKMA has significant foreign reserves, reported at over US$415 billion, and a strong track record in defending the peg, making it unlikely for a break to occur. Instead, selling USD/HKD volatility through options may be a more effective strategy, as the central bank aims to keep the exchange rate stable. Create your live VT Markets account and start trading now.

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