The Hong Kong dollar is falling against the US dollar, even though markets are comfortable with China’s outlook. Reasons we can rule out are positivity around the greenback, worries about Hong Kong’s domestic growth or a straight attack on the currency peg.
So what is it?
Widening in LIBOR-HIBOR spreads suggest that this is a traditional interest rate arbitrage. Carry traders are buying USD for the yield, so selling HKD. The Hong Kong Monetary Authority has plenty of reserves to defend the peg, and automatic, self-adjusting interest rates should kick in at the upper range, where HKMA will switch to selling USD and buying HKD. This will lower liquidity and drive up HKD rates, discouraging carry traders.
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