The Hong Kong Monetary Authority (HKMA) recently intervened in the foreign exchange market, buying just under 4 billion HKD to support the Hong Kong dollar (HKD). This action follows a rise in the USD after the Federal Open Market Committee held rates, and a less dovish statement was released, affecting major foreign exchange rates and, in turn, the HKD.
Since 1983, the HKD has been keenly pegged to the U.S. dollar through the Linked Exchange Rate System, maintaining a stable exchange rate within a 7.75 to 7.85 range. To keep this stability, the HKMA employs an automatic adjustment mechanism. This includes a Currency Board System, where each HKD issued is backed by U.S. dollar reserves at a fixed rate.
Intervention Mechanism
Moreover, the intervention mechanism is used when HKD nears its band limits. If the HKD trends toward 7.75, HKMA sells HKD and buys U.S. dollars, increasing liquidity. Conversely, if it nears 7.85, HKMA buys HKD and sells U.S. dollars, decreasing liquidity. These measures ensure the HKD remains within its trading band, facilitating long-term exchange rate stability.
Given the Hong Kong Monetary Authority’s recent intervention, we should expect liquidity in Hong Kong to remain tight. The authority is buying Hong Kong dollars to defend the 7.85 peg, which drains cash from the banking system. This is a direct response to a strong U.S. dollar, which has been bolstered by the Federal Reserve’s firm stance on interest rates.
The most direct consequence for traders is the impact on local interest rates. As we have seen, the one-month Hong Kong Interbank Offered Rate (HIBOR) has already climbed to 5.4%, now trading at a premium to its U.S. counterpart. This trend is likely to persist as long as the Fed remains hawkish, creating opportunities for those trading interest rate swaps and futures.
We’ve seen this pattern before, particularly during the aggressive Fed tightening cycle of 2022-2023, where repeated interventions pushed HIBOR sharply higher. Betting against the HKD peg itself has historically been a failed strategy, but betting on higher local interest rates as a result of defending the peg has been profitable. Therefore, the focus should be on derivatives tied to HIBOR rather than the spot currency.
Impact on Equity Market
These higher borrowing costs will continue to pressure Hong Kong’s equity market. The Hang Seng Index has struggled, down about 8% year-to-date, with property and tech stocks being particularly sensitive to the high-rate environment. Traders should consider using options or futures to hedge or take bearish positions on the index.
The key driver for the coming weeks remains U.S. economic data. Recent U.S. core PCE data came in at 3.1%, still well above the Fed’s target, suggesting U.S. rates will not be coming down soon. As long as this policy divergence continues, the HKMA will be forced to defend the peg, keeping HKD interest rates elevated.
