Hong Kong Dollar Forwards Rise Most Since March After Peg Tested

Hong Kong Dollar Forwards Suggest Ackman Bet Against Peg to Fail
A Hong Kong one-hundred dollar banknote and a U.S one-hundred dollar banknote are arranged for a photograph in Hong Kong, China. Photographer: Jerome Favre/Bloomberg

Traders increased bets Hong Kong will end a 29-year-old peg to the dollar after the currency reached the upper limit of its permitted range and triggered intervention by the city’s monetary authority.

Two-year forwards strengthened 0.11 percent to HK$7.74 per dollar as of 4:46 p.m. local time, the biggest gain since March 9, according to data compiled by Bloomberg. The Hong Kong dollar’s value is kept at HK$7.75 to HK$7.85. Hedge-fund investor William Ackman, the founder of New York-based Pershing Square Capital Management LP, said Oct. 20 he is keeping a wager that would profit if Hong Kong allows its currency to appreciate.

Even with today’s advance, the forwards are only near their average level of the past three years and analysts surveyed by Bloomberg predict an end-2013 exchange rate of HK$7.76. The linked exchange rate has given Hong Kong companies stability in commercial contracts while tethering monetary policy to that of the U.S., where borrowing costs are being held down to spur hiring and prop up the housing market. Hong Kong’s jobless rate is near a four-year low and home prices are at all-time highs.

“Any change in the peg would have certain costs but highly uncertain benefits,” Robert Minikin, senior foreign-exchange strategist at Standard Chartered Plc in Hong Kong, said yesterday. A shift “is likely to be long-delayed and perhaps come in the context of full yuan convertibility,” he said, adding that China’s currency is unlikely to trade freely for another 10 years or more.

Peg Pledge

The Hong Kong Monetary Authority said it bought $603 million during New York trading hours on Oct. 19 after the local currency’s move to HK$7.75 obliged it to intervene for the first time since 2009. Sean Yokota, head of Asia strategy at SEB AB in Singapore, said today in a note he expects the peg to stay for the “foreseeable future” and recommended investors buy the U.S. dollar against its Hong Kong counterpart using 12-month forwards.

Two-year contracts touched this year’s high of HK$7.7392 today, 0.03 percent weaker than their average level of HK$7.7367 over the past three years, according to data compiled by Bloomberg. Hong Kong officials have repeatedly said there are no plans to adjust the peg and HKMA Deputy Chief Executive Arthur Yuen told reporters on Oct. 19 the authority sees no need to alter the arrangement.

Ackman’s Bet

Ackman said in September 2011 that he was buying Hong Kong dollar call options, which give investors the right to buy the currency at a set price by a specific date. The easiest way for the city to allow the currency to appreciate would be to change the peg to HK$6 per dollar and then link to the Chinese yuan over three to six years, he said at a conference last year in New York.

“Yes we continue to have the bet on,” Ackman wrote in an e-mailed response to Bloomberg questions over the weekend. He declined to say whether he would be adjusting the size of his wager now that the upper limit of the peg is being tested.

The implied volatility on one-year options for the exchange rate fell six basis points, or 0.06 percentage point, today to 0.90 percent, according to data compiled by Bloomberg. The gauge, which traders use to set prices of options contracts, signals the expected pace of swings in an underlying currency.

Hong Kong’s dollar was little changed today at HK$7.7505 versus its U.S. counterpart, after advancing 0.02 percent last week, according to data compiled by Bloomberg. The yuan appreciated 0.2 percent last week, an 11th straight gain, and South Korea’s won added 0.7 percent.

Regional Rally

“The recent increase in demand for the local currency is related to a less strained European market, weakness in the U.S. dollar and declining U.S. interest rates, which have prompted capital inflows into currency and equity markets in the region,” the HKMA said in an Oct. 20 statement that gave details of the intervention, the first since December 2009. “Upward pressures have similarly been observed in other Asian currencies.”

Policy makers from around the world have bemoaned the economic threat of stronger exchange rates as asset purchases by the Federal Reserve boost the supply of dollars. At International Monetary Fund meetings in Tokyo this month, Brazil’s Finance Minister Guido Mantega vowed to shield his country from the “selfish” monetary policies of some developed nations, while Philippine central bank Governor Amando Tetangco said the Fed was causing “challenges to monetary policy in emerging markets.”

Fed, BOJ

The Fed initiated a third phase of so-called quantitative easing on Sept. 13, purchasing $40 billion of mortgage-backed securities per month, and said this will continue until the outlook for jobs improves “substantially.”

The European Central Bank and Bank of Japan have also added to stimulus. The ECB pledged last month to buy the bonds of governments that agree to austerity conditions while the BOJ boosted its asset-purchase fund by 10 trillion yen ($126 billion) and abandoned a minimum yield for the bonds it purchases.

Donald Tsang, Hong Kong’s former chief executive, said in a November interview that the local dollar’s peg will stay at least until the yuan is freely traded. China ended a peg in 2005 and its central bank said last month it is moving toward full convertibility “in a steady and orderly manner.” The goal is likely to be achieved by 2020, Chen Yulu, an academic adviser to the People’s Bank of China, said on Sept. 27 in Beijing.

Hong Kong linked its exchange rate to the U.S. dollar in 1983 when negotiations between China and the U.K. over the city’s return to Chinese rule spurred capital outflows. In 2005, policy makers committed to limiting the currency’s decline to HK$7.85 per dollar and capping gains at HK$7.75.

Home prices that surpassed their October 1997 peak and rising costs of food imports are boosting the risk of asset bubbles in Hong Kong and fueling calls for a review of the peg.

Yam’s Call

Joseph Yam, the former Hong Kong Monetary Authority chief who helped introduce the currency link and defended it against speculators during the Asian financial crisis, said in June the city should review the exchange-rate system. Alternatives include widening the trading band or turning the range into a “corridor” whose width, slope and center could be periodically reviewed, he suggested.

Yam was the most senior serving or former Hong Kong official to speculate on changes to the currency link. He fended off a speculative attack to weaken the Hong Kong dollar and break the peg during the Asian financial crisis in 1998, a policy that involved $15 billion of stock purchases and proved profitable for the city.

China Outlook

The rally in the Chinese currency, which touched a 19-year high of 6.2446 per dollar on Oct. 18, has spurred demand for Hong Kong dollars as investors bet the city’s economy and stock market will benefit from a brightening outlook for China.

The city’s benchmark Hang Seng Index of shares has risen 8.2 percent since the Fed’s September announcement of more asset purchases and climbed 19 percent from this year’s low on June 4. China released data last week showing pickups in industrial production, retail sales and fixed-asset investment for September, signaling growth may be rebounding after a seven-quarter slowdown.

“Funds continue to flow into Hong Kong given the monetary easing in the U.S. and Europe,” said Kenix Lai, a currency analyst at Bank of East Asia Ltd. in Hong Kong. “That’s evident by the rising stock market and property prices. I expect HKMA will still have to intervene in the near term as capital inflows continue.”

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