Markets | Hong Kong dollar’s longest rally in five years is burning shorts

Hong Kong dollar bears are abandoning bets the currency will weaken, squeezed by the longest streak of gains in more than five years.
The local dollar rose as much as 0.13% to 7.7867 versus the greenback on Monday, taking its six-day gain to about 0.5% – a large move for a pegged exchange rate. Supporting the advance are bets that borrowing costs will remain elevated versus falling U.S. dollar rates, as banks hoard cash for year-end regulatory checks. An easing of trade tensions between China and the U.S. has also helped, with foreign funds snapping up stocks in Hong Kong.
While the former British colony keeps its currency on one of the world’s tightest leashes, the Hong Kong dollar is no stranger to painful stampedes – it surged the most in 15 years in September last year despite no obvious trigger. Short-sellers are fleeing yet again, with a gauge tracking bearishness in the options market tumbling to a five-week low. Analysts predict the currency will hold in a new trading range after the latest bout of strength.
“The currency is benefiting from the unwinding of short positions and capital inflows into the stock market,” said Tommy Ong, managing director for treasury and markets at DBS Hong Kong Ltd. Still, “it will fluctuate between 7.78 and 7.82 in the coming three months without touching either side of its trading band because interest rates won’t fall sharply next year and the inflows won’t be sustainable.”
Pegged to the U.S. dollar since 1983, the Hong Kong dollar is often a dull currency. While its trading band of 7.75 to 7.85, set in 2005, has never been broken, it keeps getting tested. The central bank was forced to defend the peg on multiple occasions in the past two years, shrinking the city’s liquidity pool.
That’s in turn made the local dollar more volatile, and particularly vulnerable to shifts in demand for cash. It means large share sales or dividend-payment season can cause spikes in interest rates and dramatic moves in the currency.
This time, a short squeeze is exacerbating a rally that started amid speculation the liquidity would tighten into year end. But while there’s some evidence of that happening, it’s nothing like the sudden rush that in June pushed local borrowing costs to their highest since 2008. The Hong Kong dollar’s one-month interbank funding rate, known as Hibor, rose 9 basis points to 2.6% yesterday, the highest level in a month. Other tenors also remain off their 2019 highs.
It’s all sounding the death knell for the Hong Kong dollar carry trade, a once-popular strategy where investors borrowed the currency cheaply to invest in higher-yielding American assets. That trade turned unprofitable in June, when the cost to borrow the Hong Kong dollar turned higher than the income a trader can expect on U.S. dollars for the first time this year.
The Hong Kong dollar rate has been elevated since last month, with the premium over its U.S. counterpart briefly touching the highest since the 1990s. It was higher than the income for U.S. dollar assets for 27 straight days as of Friday, the longest stretch in four years.
“The Hong Kong dollar can stay stronger than 7.8 for some time,” said Becky Liu, head of China macro strategy at Standard Chartered Plc, adding it won’t touch the strong end of the band in the foreseeable future amid a weakening economic outlook. “I don’t think Hong Kong will have huge capital inflows, and the rates won’t spike much higher from here after the year-end seasonality demand” passes. Tian Chen, Bloomberg