HKD Drops Most Since ‘03

The Hong Kong dollar sank by the most in more than a decade and speculation mounted in the options market that the city’s 32-year-old currency peg will end as investors lose confidence in Chinese assets.

The local dollar dropped as much as 0.28 percent — its biggest intra-day loss since October 2003 — to a four-year low of HK$7.781 versus the U.S. dollar. Options prices indicate there’s a 27 percent chance the currency will weaken beyond its permitted trading range of HK$7.75-HK$7.85 by the end of this year, up from 9.5 percent on Dec. 31, Bloomberg data show. The offshore yuan was 0.7 percent weaker as of 6:17 p.m. local time, having slipped to a five-year low last week.

Hong Kong’s fortunes are increasingly entwined with those of China, an economy that’s forecast to expand this year at the slowest pace since 1990, and the local currency’s link to the U.S. dollar can come under pressure when sentiment toward the mainland deteriorates. The yuan has fallen 5.8 percent in Shanghai since a surprise devaluation on Aug. 11, even as the central bank burnt through $321 billion of its foreign-exchange reserves supporting the currency over the last five months.

While the yuan’s depreciation does drive haven demand for the Hong Kong dollar, “another dynamic has entered the equation and that dynamic is a potentially large devaluation of the renminbi,” said Mirza Baig, head of foreign-exchange and interest-rate strategy for Asia Pacific at BNP Paribas SA in Singapore. “That dynamic has perhaps become a bit more acute in recent days. If the renminbi weakens a lot, I don’t see how Hong Kong would escape speculation of de-pegging as well.”

Peg Speculation

The Hong Kong dollar was linked to the greenback in 1983, when negotiations between the U.K. and Beijing over the city’s return to Chinese rule spurred an exodus of capital, and policy makers in 2005 committed to limiting declines to HK$7.85 and capping gains at HK$7.75. It traded at the strong end of the range as recently as Jan. 4.

The notional value of outstanding put options carrying the right to sell the Hong Kong dollar at rates weaker than HK$7.85 has climbed in the past month to $11.06 billion from $9.49 billion, Depository Trust & Clearing Corp. data show. One-year implied volatility on the Hong Kong dollar, a measure of price swings cited by traders when pricing options, has doubled so far this month to a 12-year high of 3.41 percent.

HKMA Pledge

Hong Kong Monetary Authority Chief Executive Norman Chan said last month the local dollar’s peg was the cornerstone of financial and monetary stability in the city and there were no plans to amend it.

The government “is fully committed to maintaining the linked exchange-rate system, which continues to serve Hong Kong well,” a spokeswoman for the authority said Thursday. “We see no need and have no intention to change the system.”

It’s not just Hong Kong’s currency that’s out of favor. The Hang Seng Index of shares has already retreated 10 percent this year, while CLSA Ltd. predicts property prices will drop 8 percent this quarter after a 7.5 percent decline over the last three months.

“The declines in offshore yuan and the risk-off sentiment have led to a selloff in Hong Kong’s equities market, which causes capital outflows from the city and pressures the local currency,” said Ken Cheung, a strategist at Mizuho Bank Ltd. “With the Hong Kong stock market declining and heightened worries over China’s economy and markets, I see further weakening of the Hong Kong dollar.”

Bloomberg

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