How long can it last?
That’s what watchers of Hong Kong’s markets are asking as the gap between local and U.S. interbank rates widens to the most since 2009. The city’s currency peg to the greenback effectively ties its monetary policy to that of the U.S., making the growing differential all the more curious.
Now things may be changing, with forward points and interest-rate swaps in Hong Kong’s dollar starting to bottom out. The reasoning is simple: with the currency having fallen to the middle of its permitted band and the U.S. expected to continue raising rates, it’s a matter of time before the city’s exchange rate reaches its weak limit, forcing the local monetary authority to suck in liquidity.
“Once the Hong Kong dollar depreciates to a certain point, people will start to be scared there will be capital outflows, which should cause rates to rise,” said Ken Cheung, a foreign-exchange strategist at Mizuho Bank Ltd. in Hong Kong. “We’re at this point now.”
As the Hibor-Libor gap widened, Hong Kong’s dollar has weakened 0.7 percent in 2017, putting it on course for its worst year since the current band was put in place in 2005. It traded at HK$7.8108 as of 8:53 a.m. local time on Friday, near a 1 1/2-year low of HK$7.8139 reached on Monday.
Asian equities and bonds look poised to join a global selloff after central banks from Europe to the U.S. struck a more hawkish tone in recent weeks. U.S. jobs data due Friday will shed more light on the strength of the American economy, after a gauge of data surprises rebounded this week.
Hong Kong’s interbank rate, known as Hibor, has been below the U.S.’s Libor almost every day since February 2016. The flood of liquidity that flowed into the city since the global financial crisis has mostly remained, and the loan-to-deposit ratio is low.
But when rates rise more quickly, there are bound to be consequences in a city where surging real estate prices have made homes the least affordable in the world and equities are fresh off a two-year high. Developers, which aren’t bound by regulations on bank loans, have even been offering mortgages with high loan-to-value ratios to entice buyers.
One way the Hong Kong Monetary Authority could absorb funds before the currency reaches the weak end of its HK$7.75-7.85 band is by issuing Exchange Fund Bills. Still, this is unlikely as the de facto central bank wouldn’t want to give the impression it’s trying to sway Hibor, Ronald Man, a strategist at Bank of America Corp., wrote in a note.
To lock in lower rates, corporations sold a record HK$131 billion of Hong Kong dollar bonds last quarter.
It remains to be seen whether market sentiment has changed as forward points and swaps may have rebounded because of seasonal demand for the local currency at the end of June, said Ryan Lam, head of research at Shanghai Commercial Bank Ltd. in Hong Kong.
“Such a wide Hong Kong dollar-U.S. dollar gap is not normal,” he said. “Will Hong Kong dollar rates rise more quickly? I think so.”