The Hong Kong Monetary Authority (HKMA) intervened again by selling USD/HKD to support the Hong Kong dollar, purchasing 3.38 billion HKD. The HKD has been near the weaker end of its allowed trading band, causing HKMA to take action.
Since 1983, the HKD has been pegged to the U.S. dollar through a Linked Exchange Rate System (LERS), maintaining a value close to 7.80 per U.S. dollar, with a trading range allowed between 7.75 and 7.85.
Hong Kong’s Currency Board System
The HKMA maintains the HKD’s exchange rate using a currency board system, which ensures every HKD is backed by U.S. dollar reserves. Changes in the monetary base reflect foreign exchange movements, tying currency circulation to liquidity levels.
The HKMA employs an intervention mechanism to manage the HKD within its range. If the HKD nears the strong side of 7.75, the HKMA sells HKD and buys U.S. dollars, increasing liquidity. Conversely, if it nears the weak side of 7.85, the HKMA buys HKD and sells U.S. dollars to reduce liquidity, ensuring exchange rate stability.
We see the Hong Kong Monetary Authority is actively defending the peg by buying local currency. This action reinforces the 7.85 level as a very firm ceiling for the USD/HKD pair. For derivative traders, this makes selling call options with strikes at or above 7.85 a compelling strategy due to the high probability of them expiring worthless.
This intervention is a direct result of the interest rate difference between the US and Hong Kong. As the HKMA buys HKD, it drains liquidity from the system, which should push Hong Kong interbank rates (HIBOR) higher. We can expect short-term HIBOR to become more volatile and spike in the coming weeks.
Impact of US Rate Hikes
This isn’t a new development; we have been watching this play out since the aggressive US rate hikes began back in 2022. The HKMA’s aggregate balance, a key measure of interbank liquidity, has fallen from over HK$300 billion in early 2022 to its current level around HK$75 billion. This sustained drain shows the long-term pressure on the currency.
While the interventions keep spot USD/HKD price volatility extremely low, it creates tension elsewhere. We should anticipate higher volatility in forward points and interest rate swaps linked to HIBOR. This creates an environment where options strategies that profit from low spot movement but rising interest rate volatility could be attractive.
The forward market is directly pricing in these rate dynamics. We are seeing USD/HKD forward points trade at a deepening discount to the spot price, reflecting the higher borrowing cost for the Hong Kong dollar. Traders can use forward contracts to position for a further widening of this HIBOR-SOFR spread.
