HK dollar carry trading with widest yield gap since 2007

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(Bloomberg) — The Hong Kong dollar is fast approaching the weak end of its trading range against the greenback as traders sell the currency to buy higher-yielding U.S. assets.

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The local exchange rate has been one of the worst performers globally over the past two months, falling 0.74% against the US dollar, and last traded at HK$7.8473. A devaluation above HK$7.85 will result in intervention by the city’s de facto central bank.

The currency’s weakness is being driven by a collapse in local borrowing costs, which makes holding the Hong Kong dollar less attractive than its American counterpart. The one-month interbank funding cost for the currency known as Hibor fell to 2.4% from a peak of 5.08% in early December. Comparable interest rates for the greenback, or Libor, are 4.57%, resulting in the largest spread since 2007. The difference makes shorting the Hong Kong dollar profitable, leading to a revival of the carry trade.

The collapse of the currency could reignite the debate about its future. Bill Ackman said in late November that he was betting heavily on a collapse in the Hong Kong dollar, a trade backed by hedge fund manager Boaz Weinstein, founder of Saba Capital Management.

Currently there is sufficient liquidity among capital inflows and demand for credit is still weak. Money retreated as investors bet on a rebound in China after the nation moved away from Covid Zero, with the benchmark Hang Seng index up almost 50% since the end of October.

What is the Hong Kong Dollar Peg and Why It Matters: QuickTake

However, economic activity is still subdued. The city’s gross domestic product fell 3.5% last year, the third decline in four years, while house prices fell about 16%. Hong Kong’s dollar loan-to-deposit ratio fell to 88.4% at the end of December from 89.6% at the end of November as deposits in the currency rose and loans fell, according to the Hong Kong Monetary Authority.

As a small and open economy, Hong Kong is particularly vulnerable to cash inflows and outflows. The city uses the pegged exchange rate system to manage monetary policy and prevent local borrowing costs from deviating too much from US interest rates. HKMA intervention when the weak end of the trading range is reached will tighten liquidity and thus put pressure on local borrowing costs.

The frequent divergence of the city’s economic conditions from those of the United States led to bets that the bond would break. Ackman, the founder of hedge fund Pershing Square Capital Management LP, said on Twitter in late November that his firm owns a “large notional position” in Hong Kong dollar put options, betting that the peg with the greenback will eventually break without clarifying the size. of the bet.

Boaz Weinstein sees a 200-to-1 payout potential in shorting HK dollars

Part of Ackman’s premise, which referred to the Bloomberg Opinion column by Richard Cookson, is that for Hong Kong, a Chinese city deeply linked to the mainland’s slowing economy, the monetary policy of the States Uniti no longer makes sense to be obliged.

Such bets have not worked in the past. Kyle Bass, the founder of Hayman Capital Management, and George Soros both tried and failed to bet on the collapse of the currency. Ackman himself thought the 2011 category would break on the strong side.

The HKMA has repeatedly said the pegged exchange rate regime – a currency peg that has existed largely intact for nearly 40 years – will remain unchanged. The city is well equipped to deal with external shocks and has more than $400 billion in foreign exchange reserves.

–With the support of Wenjin Lv.

(Updates the currency movement in the second paragraph.)

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