Hong Kong dollar jumps into strong half of its trading band

Hong Kong’s dollar climbed into the strong half of its trading band against the greenback for the first time since July, boosted by elevated borrowing costs in the city.

The currency climbed as much as 0.13% to 7.7982 per dollar yesterday, crossing the 7.8 threshold. Local interbank rates have stayed high since November, outstripping the income a trader can expect on U.S. dollars. That’s undermined the so-called carry trade, where traders sell Hong Kong dollars and buy greenbacks, which had been profitable for years. Equities in the city also rose.

The Hong Kong dollar’s strength is also coinciding with year-end regulatory checks on banks that typically sees higher demand for cash. That may lock up funds, tighten liquidity and stoke local rates into the final days of 2019. The Federal Reserve on Wednesday left interest rates unchanged and signaled it would stay on hold through 2020, limiting the room for Hong Kong rates to fall even after the seasonal factors are out of the way.

“A softer dollar, better yield differential, perhaps some easing off on the outflows may have contributed to the sharp move that we’ve seen,” said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd. “After the Fed policy decision overnight, the dollar is staying softer.”

The Hong Kong Monetary Authority said yesterday that foreign exchange and money markets continue to operate smoothly and that the exchange rate remains stable.

One-month interbank funding costs for the currency, known as Hibor, have been higher than comparable rates on the greenback for 24 straight sessions – the longest stretch in four years. That means investors who had profited by borrowing the Hong Kong dollar cheaply and selling it against higher-yielding currencies since 2017 now may have to shift their strategy.

The Hong Kong dollar Hibor climbed above the greenback’s funding costs, known as Libor, last month, and has remained elevated. The premium briefly reached the highest since the 1990s. That came as large share sales in the city drained liquidity and six months of political unrest stoked concern about capital outflows.

Before mid-2019, Hibor had been lower than Libor for most of the past few years. The short Hong Kong dollar trade became so popular that the currency was repeatedly pushed to the weak end of its trading band against the greenback, prompting the local de facto central bank to intervene.

The Hong Kong dollar will likely return to the weak half of the band as year-end effects fade, said Eddie Cheung, an emerging markets strategist at Credit Agricole CIB.

“That’s because we currently don’t have major drivers for strong inflows, the city’s economy will face significant pressures in the first half and the medium to long-term prospects on the trade war aren’t great,” he said.

The Hong Kong dollar pared its gain to 7.8020 as of 10:46 a.m. local time. The benchmark Hang Seng Index added 1.4% and was set for the highest close since Nov. 19. Bloomberg