In late September, the HK$ jumped by over 0.63% within a single day – not significant by the standards of regional Asian currencies, but a massive movement for the tightly controlled góng yùn. The rationale for the rebound (Fig. 1a) could have major implications for HK$ cash investors and the local economy.
Hong Kong operates a linked exchanged rate system (LERS), with the Hong Kong Monetary Authority (HKMA) supporting the currency in a tight range between HK$7.75 on the strong side and HK$7.85 on the weak side.
In the past few years, massive liquidity inflows propelled the HKMA’s aggregate balance to a record high of HK$424bn (Fig. 1b) and pushed local Hibor rates sharply lower. At the same time, Federal Reserve (Fed) rate hikes were nudging US Libor rates higher, widening the historically narrow Hibor/Libor spread to record levels.
This unusually wide spread created a profitable trading opportunity, allowed investors enjoy positive carry while shorting the HK$ – forcing the currency towards the weak side of convertibility. Eventually in April, the HK$ breached the weak side, triggering HKMA intervention. However, despite several subsequent rounds of HK$ purchases by the monetary authority the currency remained firmly anchored at 7.85 until the end of September when it suddenly appreciated by 0.63% within one day. This was the largest movement in almost 14-years and pushed the currency over half way across its trading range towards the strong side of convertibility.
Three factors provoked this big, little jump: Firstly, the decline of the Aggregate Balance by over HK$350bn to a mere HK$76bn reduced local liquidity and increased the volatility of the currency and Hibor. Secondly, the realization that the HKMA was determined to support the LERS and had ample reserves to do so eliminated the possibility of further currency depreciation. And finally, with the Federal Reserve firmly on track to deliver four rate hikes in 2018 and additional hikes in 2019, the gravitational pull of higher US rates finally thrust Hibor upwards (Fig 2a), narrowing the Hibor/Libor spread (Fig 2b).
These developments have greatly reduced the rationale and profitability of the short HK$ trade. However, with liquidity still ample, the ability of the currency to continue appreciating or the Hibor/Libor spread to tighten further remains low.
Having resisted the urge to raise their prime rates following the previous seven Fed rate hikes, local banks finally succumbed to the pressure of higher funding costs and tighter liquidity – boosting their key mortgage rates following the September Fed hike. Assuming banks continue to increase rates in parallel with future Fed fund rate hikes, prime rates could peak at approximately 6%. While a housing shortage and robust employment remain supportive, the rising cost of Hibor and Prime linked mortgages will remove an important catalyst for further home price increases.
In contrast, for long suffering HK$ cash investors, the rapid increase in deposit and Hibor rates provides welcome relief from zero interest rates, and with Hibor yields now above 2% across the curve, HK$ cash has finally caught up with its US$ counterpart as a true investment alternative.
Last month’s big, little currency jump suggests the era of a weak HK$, cheap local funding, rapidly rising house prices and low returns on cash investments is likely over.
 Cantonese for Hong Kong Dollar
 The Aggregate Balance operated by the HKMA varies with the flow of funds in and out of HK$.
 The 3-month Hibor/Libor spread hit a record wide of 118bps in March 2018
 Year to date, the Aggregate Balance has declined by over HK$104bn.