(Bloomberg) – Hong Kong dollar traders are bracing for a liquidity crunch in the banking system as the city’s de facto central bank drains liquidity to maintain the currency’s peg to the greenback.
The City’s one-year interest rate swap – an indicator of interbank liquidity expectations going forward hit its highest level since December 2018 last week. This follows currency buying by the Hong Kong Monetary Authority after the local dollar broke through the low end of its trading band at 7.75 to 7.85 per greenback for the first time since 2019.
“The rise in the IRS reflects the view that Hong Kong dollar liquidity will tighten on intervention,” said Eddie Cheung, senior emerging markets strategist at Credit Agricole. “Hong Kong dollar swaps have climbed quite rapidly although they are wiping out a lot of their US rate premium,” he added.
As the swap rate hovers near its recent high, it could rise further as the HKMA is expected to drain at least HK$125 billion to stem Hong Kong dollar weakness. The HKMA has mopped a total of HK$18 billion from the local dollar since last week, but the currency continues to hover around 7.85 against the greenback.
Additionally, the spread between the three-month Hong Kong Interbank Offered Rate, or Hibor, and the same denomination Libor remains near the widest since 2019. A wide spread allows traders to borrow the currency cheaply on the interbank market and sell it against the higher-yielding greenback, exacerbating the outflows.
Hong Kong’s rate reaction so far does not appear to be large enough to ease downward pressure on the currency as interbank liquidity remains abundant, said Frances Cheung, rate strategist at Oversea-Chinese Banking Corp. in Singapore. “More FX intervention is likely to happen,” she said.
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