The Hong Kong Monetary Authority (HKMA) took action again to support the Hong Kong dollar by selling USD/HKD and buying 3.38 billion HKD. The HKD has been close to its weaker limit in the allowed trading band, prompting the HKMA’s intervention. Since 1983, the HKD has been pegged to the U.S. dollar through a system called the Linked Exchange Rate System (LERS). The target value is around 7.80 per U.S. dollar, with a trading range of 7.75 to 7.85.

Hong Kong’s Currency Board System

The HKMA keeps the HKD’s exchange rate stable using a currency board system. This means that every HKD is backed by U.S. dollar reserves. Changes in the monetary base reflect foreign exchange movements, linking currency circulation to liquidity levels. To manage the HKD within its range, the HKMA uses an intervention mechanism. If the HKD approaches the strong side of 7.75, the HKMA sells HKD and buys U.S. dollars, increasing liquidity. On the other hand, if it nears the weak side of 7.85, the HKMA buys HKD and sells U.S. dollars to decrease liquidity, maintaining exchange rate stability. Currently, the HKMA is actively defending the peg by buying local currency. This action confirms the 7.85 level as a strong ceiling for the USD/HKD pair. For derivative traders, selling call options with strikes at or above 7.85 is an attractive strategy, given the high chances of them expiring worthless. This intervention stems from the interest rate difference between the U.S. and Hong Kong. As the HKMA buys HKD, it reduces liquidity, which is likely to raise Hong Kong interbank rates (HIBOR). In the coming weeks, we can expect short-term HIBOR to become more volatile and rise.

Impact of US Rate Hikes

This trend isn’t new; we’ve been observing it since aggressive U.S. rate hikes started in 2022. The HKMA’s aggregate balance, which measures interbank liquidity, has dropped from over HK$300 billion in early 2022 to about HK$75 billion now. This ongoing reduction highlights long-term pressure on the currency. While the interventions keep spot USD/HKD price volatility low, they create tensions elsewhere. We should expect higher volatility in forward points and interest rate swaps tied to HIBOR. This scenario makes options strategies that profit from low spot movement but rising interest rate volatility appealing. The forward market directly reflects these rate dynamics. We see USD/HKD forward points trading at a larger discount to the spot price, showing the higher borrowing cost for the Hong Kong dollar. Traders can use forward contracts to prepare for a widening of the HIBOR-SOFR spread. Create your live VT Markets account and start trading now.

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