Hong Kong Dollar: This Is Keeping Investors Up at Night

Hong Kong DollarThe Hong Kong Dollar Could Break the Market

The combination of rising U.S. interest rates and China’s economic slowdown will put pressure on Hong Kong’s economy and the Hong Kong dollar (HKD) this year. Indeed, the indications are that China’s woes and chronically depressed oil prices will be the toughest tests for the markets in 2016, fueling the potential for a market crash and pushing down the USDHKD pair.

In an increasingly interconnected world, all investments and markets are tied to each other. As the saying goes, the butterfly that flaps its wings in China causes a hurricane in the United States. Simply put, risks are global. The markets have been behaving accordingly over the past weeks, with the butterfly in this case being in Saudi Arabia and crude oil, while the financial hurricane is in China.

Hong Kong has pegged the HKD to the U.S. dollar, allowing it to trade between HK$7.75 to HK$7.85 against the American currency. However, the Hong Kong dollar fell more than 0.25% against the U.S. dollar on January 14 to mark a four-year low, triggering speculation that the currency peg may be scrapped. China’s slowdown and its weaker

currency could indeed lead Hong Kong to reconsider its peg to the U.S. Dollar.

The move was another sign of how the volatility of China’s currency, the yuan, can affect other markets. Last week, China’s currency seemed poised for more devaluations, given aggressive puts that it would suffer even more sharply. The People’s Bank of China (PBoC) countered those expectations by intervening and buying up yuan to strengthen the currency, while also forcing offshore renminbi-denominated borrowing rates higher.

The Hong Kong market lost 1.35% on January 15, as its local currency, the Hong Kong dollar, headed toward its worst consecutive two-day drop since 1992 and its lowest level against the U.S. dollar in four years. The Hong Kong dollar lost 0.1% on January 15 after dropping 0.3% the previous day. Meanwhile, the offshore yuan lost one percent of its value in the week ending January 15.

In Hong Kong, the Hang Seng Index lost about one percent, sitting around 19,600 points, with much of the blame going to the weak Hong Kong dollar.

USDHKD Relationship Suffering

The Hong Kong dollar, which moves in a narrow fluctuation band vis-à-vis the U.S. dollar, is trading at around 7.8, but it found itself caught in a perfect storm caused by the yuan on January 13. The HKD suffered its fastest single-session drop in 12 years as a result.

“Maybe China goes to where the dollar-Hong Kong is. That’s your first port of call—7.78,” said Chris Morrison, head of strategy and manager of Omni Partners’ Macro Fund. (Source: “How far can it fall? Hedge funds speak of 15 percent tumble for yuan,” Reuters, January 14, 2016.)

The Shanghai Composite index, China’s benchmark, has fallen 16.6% since the start of 2016, from 3,539 points to 2,900 points. Meanwhile, in 2015, it rose 9.41% (in 2014, it had risen 52.9%).

The Chinese situation, apart from the apparent oversupply, has also been responsible for forcing oil prices down. While the collapse of oil responds to multiple factors of supply, demand, and the value of the U.S. dollar, China plays a key role in setting expectations, too.

The message that the markets are trying to send the world is that the finance gods need China to be in good health. However, China picked up the flu in 2015 and has yet to kick it. China’s real gross domestic product (GDP) has slowed from 7.3% in 2014 to 6.9% (estimated) in 2015. In the next two years, it is projected to remain low. (Source: “China Expected to Post Weak Q4 GDP,” WEUpIt.com, January 13, 2016.) In 2016, the most optimistic growth prospects are 6.3%, with no relief in sight. (Source: “China’s GDP may be much lower than you think,” CNBC, January 11, 2016.)

China Is On the Brink of Economic Collapse

The various monetary and fiscal interventions have not worked for China, as the country also experienced the first annual loss of international reserves of the modern capitalist era.

Foreign exchange reserves have decreased by a cumulative $512 billion, according to data from the central bank. (Source: “China FX Reserves Drops A Massive $512 Billion in 2015,” ValueWalk.com, January 8, 2016.) In December alone, the reserves dropped by $107.9 billion, representing its largest ever monthly loss. (Source: “China forex reserves fall $512.66 billion in 2015, biggest drop on record,” Reuters, January 7, 2016.)

The strong dollar has exacerbated the drop of commodity prices, which together with the collapse of oil, has wreaked havoc on markets and economies vulnerable to external shocks, given they are not the ones establishing the value and pricing of their goods. Such has been the case for the yuan.

The yuan depreciated about 1.4% so far in 2016, from 6.49 up to 6.57 yuan per dollar. (Source: “Chinese stocks breach December 2014 closing low, offshore yuan weakens,” Reuters, January 15, 2016.) The USDRMD has not improved, even as Chinese authorities have tried to reassure the markets with interventions and the introduction of “circuit breakers” to absorb the impact of hoard sell-offs. They will have to devalue the yuan further in order to resolve the issues plaguing the economy, not the least of which is the real estate market.

In the last two days, China’s central bank has intervened aggressively in the offshore yuan market, traded especially in Hong Kong. It is targeting through state-owned banks to trade against the yuan, all because it decided to convert the yuan into a global currency. For the past few years, emerging countries—the BRICS in particular—led by China and India were the champions of global growth, while the developed world struggled to avoid recessions.

The higher U.S. interest rate and the Fed’s announced plans for successive, if minute, increases will put further pressure on the HKD, according to Hong Kong’s finance secretary, John Tsang. (Source: “Hong Kong FS Tsang Says Further HKD Drop Possible,” London South East, January 15, 2016.) But a further drop cannot be ruled out if more capital flight results, given the potential for another U.S. interest rate hike that would lead to an outflow in capital.

This is potentially damaging to the countries with currencies pegged to it, as their exports become more expensive, leading to speculation that the pegs may have to be broken to allow their currencies to weaken. (Source: “Analysts predict HK and Saudi currency pegs won’t be broken,” News.Markets, January 15, 2016.)

Things aren’t looking too bright at the moment for the Hong Kong dollar or the USDHKD and USDRMB pairs.