HK's crowded currency trade enters dangerous territory

HONG KONG • One of the world's most reliable currency bets is suddenly looking like less of a sure thing.

The Hong Kong dollar carry trade, which has produced steady returns for seven straight months, suffered a rare setback on Wednesday as the currency abruptly strengthened the most since February last year.

Its 0.1 per cent gain against the US dollar may have been tiny by global standards, but it jolted investors who had positioned for declines by borrowing in Hong Kong to invest in higher-yielding American assets.

The trade had been a consistent winner this year after interest rates in the United States rose and those in the former British colony held near rock-bottom levels. But now the tightly-managed exchange rate is turning more volatile as it approaches the weak end of a trading band imposed by the city's de facto central bank.

The Hong Kong Monetary Authority (HKMA) triggered Wednesday's spike by announcing plans to sell additional debt instruments called Exchange Fund Bills.

While the HKMA said its decision had nothing to do with the currency, some traders speculated that the move was designed in part to drain cash from the financial system and guide local interest rates higher.

That would help support the Hong Kong dollar before the HKMA is obliged to defend the currency at HK$7.85 versus the greenback - something it has not had to do since the current trading band was implemented in 2005.

"The long carry trade - long US dollar against Hong Kong dollar - has been one of the easiest trades this year and it's probably a little crowded as well," said Mr Gary Yau, a strategist at Credit Agricole CIB in Hong Kong.

"As the spot is near unprecedented territory, there is a lot of uncertainty and views by different parties in the market, which is why you get such sharp moves and more volatility than usual."

Before the HKMA announcement, Hong Kong's dollar had fallen to HK$7.8278 against the US currency. It strengthened to HK$7.8164 by 7.30 pm local time on Wednesday.

The HKMA's announcement also moved currency forwards, popular contracts for betting on interest rate differences between Hong Kong and the US.

Twelve-month Hong Kong dollar forward points jumped as much as 92 points on Wednesday, the most since December.

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A version of this article appeared in the print edition of The Straits Times on August 11, 2017, with the headline 'HK's crowded currency trade enters dangerous territory'. Print Edition | Subscribe