The Federal Reserve is playing havoc with the Hong Kong dollar — and the stock market could be next.
The pegged currency has been torpedoed this year, sliding to a 15-month low versus the greenback as a mortgage war deters local banks from tightening along with the Fed. As the interest-rate differential with the U.S. widens, strategists are tipping further losses, and equity investors are taking note.
The Hong Kong dollar is within 0.2 percent of HK$7.80 per U.S. dollar, a level that could trigger outflows from the stock market, according to Ample Capital Ltd. and Core-Pacific Yamaichi. Their theory? Traders start ditching rate-sensitive equities on concern the weakness will spur officials to start buying the currency to shore up the peg, thereby boosting borrowing costs.
The Hang Seng Index traditionally moves in tandem with the city’s currency, falling when the Hong Kong dollar moves toward the weak end of its HK$7.75 to HK$7.85 per dollar trading band, as it did at the start of 2016.
Demand for Hong Kong shares as buyers flee a selloff in mainland China has helped dilute that relationship, however, with the Hang Seng rallying to its highest point since July 2015. Property stocks — likely the most vulnerable to an uptick in concern about rising rates — have driven this year’s 14 percent advance.
Hong Kong has been tightening: the city’s de facto central bank boosted its base rate twice since the start of December, tracking the Fed because of the demands of the peg, which was put in place 34 years ago to stymie capital outflows in the lead up to the territory’s return to Chinese rule. But local lenders’ reluctance to pass that increase on has seen the premium on Libor — the one-month U.S. interbank rate — over Hong Kong’s Hibor rate swell to more than 61 basis points, the most since December 2008.
Stephen Innes, a senior currency trader at Oanda Corp. isn’t overly worried, though.
- The Hong Kong dollar will probably weaken further as markets price in Fed rate hikes, but the downside will be limited at HK$7.8, he said.
- Interest rate differentials are likely to narrow as there was a gradual normalisation on that front when U.S. policy makers started to move rates previously.
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