The Hong Kong Monetary Authority (HKMA) recently stepped into the foreign exchange market, purchasing nearly 4 billion HKD to support the Hong Kong dollar (HKD). This move came as the U.S. dollar strengthened after the Federal Open Market Committee decided to keep interest rates steady and issued a less accommodative statement. This affected major exchange rates, including the HKD. Since 1983, the HKD has been closely pegged to the U.S. dollar through the Linked Exchange Rate System. This maintains a stable rate within a range of 7.75 to 7.85. The HKMA uses an automatic adjustment mechanism to keep this balance. This includes a Currency Board System, ensuring that every HKD issued is backed by U.S. dollar reserves at a fixed rate.

Intervention Mechanism

The intervention mechanism activates when the HKD nears its limits. If the HKD approaches 7.75, the HKMA sells HKD and buys U.S. dollars to boost liquidity. If it approaches 7.85, the HKMA buys HKD and sells U.S. dollars, reducing liquidity. These actions help keep the HKD within its trading band, promoting long-term exchange rate stability. With the HKMA’s recent intervention, we can expect tight liquidity in Hong Kong. The authority is purchasing Hong Kong dollars to defend the 7.85 peg, which withdraws cash from the banking system. This follows a stronger U.S. dollar, supported by the Federal Reserve’s firm interest rate policies. For traders, the immediate impact is on local interest rates. The one-month Hong Kong Interbank Offered Rate (HIBOR) has risen to 5.4%, now higher than its U.S. counterpart. This trend may continue while the Fed remains focused on controlling inflation, leading to opportunities in interest rate swaps and futures. We’ve seen a similar pattern, especially during the Fed’s aggressive tightening from 2022 to 2023, when repeated interventions pushed HIBOR much higher. Betting against the HKD peg has often been unsuccessful, but investing in higher local interest rates resulting from the peg defense has proven profitable. Therefore, traders should focus on derivatives linked to HIBOR rather than the spot currency.

Impact on Equity Market

The rise in borrowing costs will continue to weigh on Hong Kong’s equity market. The Hang Seng Index has lost about 8% this year, with property and tech stocks particularly affected by high rates. Traders may want to use options or futures to hedge or take bearish positions on the index. The U.S. economic data will be a key factor in the coming weeks. Recent core PCE data in the U.S. showed a rate of 3.1%, well above the Fed’s target, indicating that U.S. rates are unlikely to decrease soon. As long as this policy divergence persists, the HKMA will need to defend the peg, keeping HKD interest rates high. Create your live VT Markets account and start trading now.

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