New Hong Kong dollar banknotes displayed are during a press conference at the Hong Kong Monetary Authority in Hong Kong, China on 11 December 2018. Pic: AFP.

The Hong Kong dollar (HKD), after spending a whole week flush up against the upper limit of its trading range of 7.7500 – 7.8500 to the US dollar (to which it is pegged at the 7.8000 level) and forcing the HK Monetary Authority to buy US$6.3 billion to defend the peg, showed an unexpected bout of weakness last Friday and at one point hit 7.7526, its lowest level since late May.

“Hong Kong’s Resilient Dollar Looks More Shakey,” titled Bloomberg on Monday, adding the view of a Mizuho Bank currency strategist that “the depreciation might be an early sign of concerns over the US’s financial sanctions as supportive factors such as large listings and dividend payments may start to cool down later in July.”

Well, not hardly! That’s giving way to much credit to US President Donald Trump and his sanctions policy.

Bloomberg, in line with hedge fund manager Kyle Bass, has had it in for the HKD for some time now and won’t miss a beat when it comes to forecasting or “analysing” HKD doom and gloom.

But here are the facts and the very straightforward explanation.

As at this writing (8pm HK time), the HKD has made up for most of its Friday losses and, indeed, had done so by as early as 9.45am HK time, when it traded at 7.7507. Currently, the rate is 7.7508 to the USD.

The HKD, more than by any other factor, is driven by the Hibor – Libor interest rate differential. In “normal times” as in 2018 and early 2019, the gap between the two rates was negligible and the HKD moved little.

On June 30 this year, the gap was a significant 28 basis points (0.44% – 0.16%). This differential supported a very lively and profitable carry trade and defined high HKD demand.

By the end of last week, as Hibor declined and Libor yield moved up a bit, the gap narrowed to just 22 basis points and today it was down to 20 basis points.

At that differential, the carry trade rapidly loses its lustre.

So what happened on Friday? There was a substantial exodus from the HKD carry trade and the exchange rate adjusted.

Why the decline in Hibor? 

Hibor has been elevated ever since the Trump threats were issued in late May. It was 1.13% on May 25 and has since then come down steadily, to 0.38% today.

That’s not a sign of fear, but the opposite.

I expect HKD strength to be maintained. The decline in the carry trade is simply a sign of a return to less volatile times.

HKD risk reversals stand at 0.105! The options market shares my judgement.

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This report appeared first on Asia Times Financial.