US Dollar can trigger global crisis, short HKD for 20:1
Three years ago the HK protests focused our attention on the US dollar to HK dollar linked exchange rate. Back then, we speculated whether the relationship could hold in the face of Chinese ambitions, extreme levels of leverage and the US-China ‘trade war’. With some of these factors back in play, it’s worth revisiting.
Back in 2019 the band was approaching the lower level of 7.85 HK$ to US$, the floor at which the Hong Kong Monetary Authority (HKMA) keeps holds the level, and many hedge funds were speculating it would not hold (and the HK dollar devalue sharply). And yet, even as COVID-19 looked to be the straw that would break the camels back, it did not. We could make an argument that COVID-19 in fact saved the attack on the ‘peg’. As the virus spread to the US the Fed responded with unprecedented interest rate cuts. In doing so, it made the US dollar less attractive to own relative to HK dollar, and stemmed the outflow of capital that, as everywhere, searches for higher yield. Secondly, HK is a conduit for international capital to flow into Chinese listed equities. When China appeared to be a champion in fighting COVID with its zero-tolerance, while the West was slower and more staggered in its response, capital flowed back East through Hong Kong into equities.
Now, with high bond yields in the US, and the rest of world lagging, capital is looking West once again. Hong Kong is no longer in focus, but regulatory and political risks around Chinese equities, coupled with Xi’s approach to Russia, is bringing western capital back home at an unprecedented rate. To protect the peg the HKMA buys HKD using their reserves, and less HKD pushes local rates higher attractive flows back in. But maybe the speculators will be proved right. Their reasons in 2019, which I won’t go into here but are mainly around HK’s highly leveraged economy and risk of capita flight from an incursive China, may not have been wrong, only the timing.
Back in 2019 the band was approaching the lower level of 7.85 HK$ to US$, the floor at which the Hong Kong Monetary Authority (HKMA) keeps holds the level, and many hedge funds were speculating it would not hold (and the HK dollar devalue sharply). And yet, even as COVID-19 looked to be the straw that would break the camels back, it did not. We could make an argument that COVID-19 in fact saved the attack on the ‘peg’. As the virus spread to the US the Fed responded with unprecedented interest rate cuts. In doing so, it made the US dollar less attractive to own relative to HK dollar, and stemmed the outflow of capital that, as everywhere, searches for higher yield. Secondly, HK is a conduit for international capital to flow into Chinese listed equities. When China appeared to be a champion in fighting COVID with its zero-tolerance, while the West was slower and more staggered in its response, capital flowed back East through Hong Kong into equities.
Now, with high bond yields in the US, and the rest of world lagging, capital is looking West once again. Hong Kong is no longer in focus, but regulatory and political risks around Chinese equities, coupled with Xi’s approach to Russia, is bringing western capital back home at an unprecedented rate. To protect the peg the HKMA buys HKD using their reserves, and less HKD pushes local rates higher attractive flows back in. But maybe the speculators will be proved right. Their reasons in 2019, which I won’t go into here but are mainly around HK’s highly leveraged economy and risk of capita flight from an incursive China, may not have been wrong, only the timing.