Hong Kong Dollar and Why Hedge Funds Target It

broad ust dollar weakening. Hong Kong was not alone. We saw a lot of speculation around Taiwan, Korea and other carrier currencies, but Hong Kong experienced very aggressive volatility as a result, so it touched briefly the strong end of the band at seven point seventy five, prompted the Hong Kong Monetary Authority the HKMA, to intervene by buying seventeen billion US dollars and selling one hundred and twenty nine

point four billion Hong Kong dollars. So the result of that operation is a massive search in the aggregate balance, which is an indicator of interbank liquidity, that surged to around one hundred and seventy four billion Hong Kong dollars on May sixth, and that's up from just forty four billion, which had been the norm for quite a few years

prior to this big intervention. Now, that large spike in interbank liquidity fueled the widening of the three month high bore software spread, meaning the interest rates spread between Hong Kong and the rest of the world widened to and unprecedented two hundred and sixty basis points. And of course, whenever that happens, you see a lot of carry trade and demand for honkon dolla, and a lot of speculation

around what that's going to happen. Following that decline in interbank rates, the spot currency moved so within the span of a few days it went from the strong end of the band all the way towards seven point eight three, which is towards the weekend of the band, and the twelve month forward outright also rebounded from seven point sixty eight to seven point a five essentially meaning that the market was expecting that the Hong Kong dollar, which remained

on the weaker end of the band, for the foreseeable future, at least the whole year. So what happens when we hit the seven point eighty five, which we have five times over the past three weeks, is that the Hong

Kong Monitory Authority to intervene to defend the currency. So it's bought a total of seventy two billion Hong Kong dollars, sold a total of nine point two billion US dollars since June twenty six, and as a result, we've seen a declining in the aggregate balance to eighty six billion, which is still double the amount of the forty four billion prior to Liberation Day. So we are still in a very liquid situation, but we've seen a lot of action by the Hong Kong may So if I could.

the Hong Kong May has to do the same. When they cut interest rates, the Hong Kong May has to do the same. This is also called linked exchange rate system LRS LARS, and it was previously I think that's a very sort of technical term. It was previously known currency board. So we've seen examples of currency boards in Latin America. They were not very orthodox, very strict, so

they didn't succeed. Hong Kong is usually the post a child for what a currency board should be, and it was introduced in the eighties to try to address some of the issues around hot money flows. It was very volatile prior to that. We are a small export oriented or externally oriented economy. So of course the currency board does provide stability, but it comes with its costs. And there are three principles that are enshrined in the Hong

Kong Constitution, the Basic Law and that are unmovable. So this is something that oftentimes when we talk with international investors they don't understand to what extent this is part

of the law of the region. And these are that any change in the monetary base must be matched by an equivalent change in foreign exchange reserves, ensuring that FX reserves cover at least one hundred percent of the monetary base, and Hong Kong is very good, so we have one hundred and fifty percent plus FX reserves, so very very

orthodox in that front. The currency must be fully convertible on demand into a foreign anchor currency in this case the US dollar, and at a fixed rate, so we have seven eighty with the MA allowing some volatility around this band of seven eight five to seven seveny five.

And lastly, monetary policy should be rule bound and automatic, so the HKMA has no discretionary monetary power to engage in fiduciary issuing of money, so they have no say over, you know, whether they want to stimulate the economy with monetary policy, if interbank raade should be high or low,

they have no say over that. And there are ways to test the orthodoxy of a currency board through the reserve exchange pass through and we've done some research recently that proves that this pass through rate remains within zero two one hundred percent, so meeting the criteria of an

orthodox currency board. So the aim of the currency board is to reduce exposure to effects, volatility provides stability to the region, and in exchange, you have no monetary policy and you have to adhere to these very strict principles, which Hong Kong does, and there are some costs that of course.

the political will to support the currency was. So it's a topic that does come up on occasion, and I think the reason why it comes up on occasion is because there's a lot of interest from particularly hedge fund managers,

especially in the US. The reason for this is that the basic law does not dictate that the Hong Kong dollars de facto anchor currency is a US dollar, and neither does it specify a level at which the Hong Kong dollars should be pegged against the foreign anchor currency, So that loophole quote unquote continues to serve as the basis for speculation that breakage could occur. And of course

it's a tail risk. It's a fringe risk, but if you're a hedge fund manager, you can afford the losses and if you get it right, you make a lot of money. So every sort of five to ten years you get a fresh bout of someone putting, you know, options and trying to make money out of this possibility. But we think it's rather unlikely to be frank, So this is.

board is and what it does. So it's very easy to look back at historical examples in Latin America and why that didn't work, or refer back to George Soros in the eighties speculating against the Bank of England or even Thailand with the Asian financial crisis. Of course, he made vast amounts of money with those bets, and to

try to extrapolate the situation on Hong Kong. But the truth is, Hong Kong has to peg to a currency that is fully convertible according to the Basic law, and it has been adhering strictly to the rules that are enshrined in its Basic law in terms of maintaining currency board orthodoxy. The Remenbe is not a good candidate for the Hong Kong DOLLA to repeg against because the Remenbe

is not fully convertible. So what these hedge for managers have been betting on is that the Hong Kong government, for political reasons or what have you, will repeg away from US dollar and towards the Remenbe, and that is simply not possible under the current legal framework in Hong Kong. Now there is an argument to be made about whether

or not the peg is serving us. It used to be the case that Hong Kong's economy was very correlated with the global business cycle, especially prior to the two thousands, when China wasn't such a dominant force in the global economy and global trade. Since then, the Hong Kong business cycle and the Chinese business cycle have become increasingly correlated, and we have become increasingly a service provider for Chinese companies going overseas, and naturally that means that the PEG

sometimes acts as a pro cyclical headwind. By that, I mean when things are going south, it makes things even worse. So it's a pro cyclical the cycle is down and it makes things worse because typically when it happens, the FED is also hiking interest rates, as we have seen over the past few years. So there is a case to be made at some point eventually it will be

necessary to change the board. Now, the Hong Kong may has done a lot of academic research evaluating whether or not the PEG brings prosperity to the region, and the long term view is that it does. The stability provided by the PEG does bring prosperity. It comes at the cost of these periods where you have a cyclical downturn and the PEG exacerbates those pressures. Typically the government is able to use fiscal to offset some of that pressure.

What has happened is in the past couple of years post COVID, we now have a deficit which we are not allowed to have according to the constitution as well, and so they have less room to do fiscal to try to offset this. So if this situation of a strong US dollar continues, which may or may not be the case, we can get into that in a minute.

But then, yes, the fiscal wouldn't be enough to upset this, so Hong Kong would be in a very stackflationary outcome for a long time, and possibly at that point they could consider moving into something different. In my opinion, it won't be a repeg, It will be a completely different EFTs regime based on a basket of currency, similar to what we see in Singapore. That could happen, but I don't think the betting on a repag to the remybe is going to make anybody any money anytime soon.

from US dollar towards other regional partners. So Hong Kong could adopt a similar mechanism, and in that case they would no longer be subject to the FED, so they wouldn't have to cut or hike interest rates in tandem with the FED, but they could manage monetary policy easing and tightening by addressing the slope or the pace at which they allow the currency to appreciate in trade weighted terms against their partners. So typically that's what Singapore does.

Hong Kong could study and doing something similar, but it would require a change in the basic law and that is not something that you do lightly.

higher inflation globally, and also higher tariffs. So US consumers are now facing eighteen percent tariffs that's unheard of since the nineteen thirty So we are entering and charted territory in a world where the dollar is structurally stronger and rates structurally higher than Yeah, Hong Kong faces significant stackflationary risks. Meaning lower growth and deflation. And keep in mind that we are importing a lot of deflation from China, perhaps more so than any other economy, so that would be

a risk for Hong Kong. Where this changes, however, is if we enter a world of US dollar weakness. So if the US dollar you know what triggered this big surge in interbank liquidity. It was the announcement of reciprocal tariffs in April. It was investors being concerned that a lack of visibility on US trade policy and to some extent, domestic policy was eroding US exceptionalism and some of the

rights that come with that, including US dollar strengthening since COVID. Essentially, so if we move away from a world where the US dollar strengthens structurally and you have upside on US equities, if we move to a world where US total equity returns are flat because you have currency weakness, then it doesn't put pressure on the Hong Kong economy to the

same extent. So we do think that the FED will start to cut interest rates towards the fourth quarter of this year, Hong Kong may will do the same, and then we are also expecting red cuts in twenty twenty six. So my guess is that the debate is going to phase out and fickle out over the coming months and it won't be such an important point on the policy age, and then you won't have US hedgeman managers making any

bets against the Hong Kong DOLLA until conditions reverse. So potentially if we enter another phase of like two to three years of US dollar strengthening, then it will become another topic before the time being. I think it is just a matter of waiting.

place for China. So until China is able to fully liberalize its capital accounts, which is perhaps a topic of another podcast. I mean, if they do, then at that point it might make sense to repag against them inb because it would be fully convertible. But the conditions for them to be able to achieve that will you know,

it will take me with ten or twenty years. So during that period they will still require an offshore center in order to facilitate their technological upgrade and enable that some of these up and coming tech companies can raise US dollar financing. So we are seeing a huge surge in the IPO pipeline in Hong Kong because borrowing rates are lower and US dollar is still a ruble reserve currency.

So I think even if we are in a situation where that Hong Kong dollar remains on the weekend of the band for so long, because the speculation by us A trial managers is, you know, they're so committed to this trade that they push the Hong Kong are made

to burn through all of its effects reserves. At that point in China injects like they will not risk accessing US dollar capital markets via Hong Kong in exchange for some political you know, making a political statement about the US dollar through a repeg to a currency that is not fully convertible in itself. So unless they all agree, I don't think any individual US actual manager has enough

cash at hand to burn to achieve this outcome. But theoretically, if it was possible, I think the Chinese government would intervene because of the important role that Hong Kong serves as an offshore intermediary.

is just slightly above zero percent. The three month high bore, which banks are now using to price mortgages is around two percent, so we do expect that hybrid rates will go up, but they will stabilize at levels that are higher than or we had prior to the Liberation Day tariffs because of a myriad of factors, including the fact that you are having more easy in Man and China, and the demand for credit in Hong Kong with the

situation in the housing sector just isn't very high. So we do think that higher rates go up from here, but they will stabilize at lower levels, and that is, in my opinion, actually moderately stimulative for Hong Kong assets, including both equities equities first and then even real estate.

So now with mortgage rates at two percent, yields at three percent, there's a one percent positive carry, perhaps not super enticing, but enough for a certain group of the population to maybe dip their toes if it's the first time buying a house, for example. So I think it actually is a net positive for the Hong Kong economy, and I think it's a positive that lasts until the end of the year. Beyond that, really it's a matter of how steep the FED cutting cycle is going to be.

They've been on a pause since December, and so if they do four, it's definitely very good for Hong Kong. We will have a week a dollar and then lower rates overall. But if for whatever reason, inflation overshoots domestic to private, domestic demand in the US remains robust and the FED can't do as many cuts, then Hong Kong will continue to be in a bit of a tight spot.

something excess billion in the aggregate base. So if you have additional demand, because you know the IPO cycle is strong, so you have demand for honknd doll because people want

to participate in that upside. And you also have this hype around stable coin, and I don't think anyone understands what the future of stable coin is and whether it's going to fuel the dollarization trends or not, but it is possible that at the very least people will want to participate, and so it could fuel demand for hongkon dola.

In that case, you would of course see interbank liquidity getting drained and you would see the interbank rates going up, and that would mean that this moderately stimulative condition that Hong Kong is enjoying right now would no longer be in place. So it does actually make the life of

them a little bit more complicated. But if that's the case, I think they might be okay with it because of the potential long term gains of being an innovator or a first mover in the stable coin and cryptocurrency space, which seems like something that they tried to promote.

that list. So could this be perceived, you know, Hong Kong authorities going in to defend the currency. Could it be seen potentially as currency intervention and sort of catch Trump's eye?

a currency manipulator. Perhaps some of it Trump's advisors are still thinking about the early thousands when China essentially kept its currency undervalued to benefit from all of the upsides from joining WTO and participating in the global system. But more recently, what we have seen since the introduction of the CFTs, the current FS regime in China in twenty fifteen, is that the currency has structurally weakened about one point three percent per year, and that's in line with structural

slowdown in the Chinese economy. So China is intervening to prevent that from being even faster, So from preventing that structural slowdown from taking place even faster, potentially resulting in capital outflow pressures and exacerbating If you have a big capital outflow, it will be very difficult for you to restructure the domestic debt. So they're trying to focus on that domestic debt restructuring before they allow any sort of

outflow or reform to the capital account front. But so we have seen a ten year period of weakness with the Chinese Central Bank intervening to prevent this from being even more dramatic. And I think Trump's understanding of the situation isn't one hundred percent correct, so it could get his attention, but I think that even if it does, it might be futile because they are a bigger fish to fry. For example, what comes next to what are the next ten years of the Roman bee? I think

that's probably a bigger policy question for the US. And by the way, we have also looked at research on FX regimes in China and they do seem to pivot

every ten years or so. So the time is ripe for China to announce a NEWFX regime, and the world is moving towards increased by furcation reduced trade dependency on the US, So I think that is a bigger question if China enters a phase where they allow the currency to depreciate even further over the next ten years, but in a controlled manner, so they don't have outflows, but they reap the benefits from being able to preserve their terms of trade and export high value added goods while

simultaneously restructuring their domestic debt. That's a bigger threat than Hong Kong Dolla being very by the books and sort of following the Currency Board orthodoxy and principles. I would say it's more likely that he will be dissatisfied with the pboc's inability to strike a deal on the currency front. So this is one of the things they're talking with Korea and with Japan. China has been obsessed with the

Plaza chord for the longest time. They have studied the Japanese last decades, and if you look at the discourse amongst domestic economists in China, it's perceived as a big mistake. So the Plaza chord was a big mistake for Japan. That's to be debated, but in Chinese policy circles they consider that that was a trigger for the last decades. So I don't think China is going to agree to

strengthening their currency against the US dollar. So I think that whatever happens in Hong Kong could catch his eye, but very soon he will focus on the situation in China because it looks like they're going to allow the currency to appreciate even more over the next ten years as part of a new FX regime.