hkskyline
June 15th, 2005, 09:45 PM
HK dollar enters new era
Susan Fenton
June 16, 2005
For the first time in nearly 22 years, dealers in Hong Kong know where the buck stops - but they're not ready to trade it.
Authorities last month made a historic change to the Hong Kong dollar peg, creating a ceiling for the first time and lowering its long-standing floor.
The move, designed to curb pressure from hot money flows on speculation that Hong Kong would follow a revaluation of the yuan, established a 1.3 percent band of 7.75 to 7.85 per US dollar in which the currency can now trade.
But dealers say the market has lost vigor and it will take time before a genuine market develops based on views about the Hong Kong dollar and economy, as opposed to flows from exports, imports and investments.
"Officially the band has widened but you need a reason to trade," said Carlos Cheung, chief foreign exchange dealer at Bank of East Asia.
"Now there's no volatility, so no matter whether you buy or sell the Hong Kong dollar, it won't move."
So far this month the Hong Kong dollar has been stuck between 7.7730 and 7.7855 per dollar.
It will take heavy fund flows to push it up to 7.75 and the only likely catalyst for that in the current environment is speculation on the yuan.
In theory, dealers could have traded the Hong Kong dollar more actively previously, because there was no defined ceiling.
The peg was introduced in 1983 amid a crisis of confidence about Hong Kong's future given the then-British colony was to be handed over to China in 1997. The floor gave the market certainty, while there was no need for a ceiling.
"Ten to 15 years ago the Hong Kong dollar moved in a very narrow range," said Dennis Wong, chief foreign exchange dealer at Hang Seng Bank.
"Hong Kong's future post-1997 drove the market but only for a short while: the Hong Kong dollar was going down but due to the peg it could only go to 7.8 so there was not much activity."
Speculation of a change had dominated Hong Kong dollar trade since late 2002, when markets began to aggressively bet on a revaluation of the yuan.
At first, there was speculation Hong Kong would devalue and traders positioned for a convergence with the yuan. But from late 2003, the speculation changed to a Hong Kong dollar revaluation and the currency strengthened. The ceiling changes that.
"It's certainly killed some people's idea of wanting to speculate on the yuan via the Hong Kong dollar," said James Malcolm, currency strategist at Deutsche Bank.
The forwards market has been hit by reduced speculative flows and spot trade is lackluster, contrary to some analysts' expectations that a wider trading band would ignite the market.
Data from the Bank of International Settlements shows the Hong Kong dollar market is the biggest in Asia after the Japanese yen and Australian dollar.
Hong Kong dollar turnover in spot, outright forwards and foreign exchange swaps averaged US$33.2 billion a day in April 2004, almost double that for the Singapore dollar, said the BIS.
Trading volume in the Hong Kong dollar hit a record high May 18 on news of the changes, up nearly eight-fold from the 2005 daily average, as speculators took flight, data showed.
Since then volumes have slipped below this year's average, according to market players.
The currency has yet to test its cap and has been swayed by genuine capital flows in and out of the territory.
Wong thinks that with time, the market will develop.
"There will be more volatility because the band is wider so there is more room for movement in the spot rate. But there is no news to stimulate the market," he said.
"Players need to get used to the new measures. They are just waiting to see what happens. There are no big positions in the market."
The new band does increase the attractiveness of arbitrage trade - the exchange of Hong Kong for US dollars or vice versa to benefit from widening spreads between US and Hong Kong interest rates, but only at its boundaries.
In the middle of the band, currency risk is greater than before because of the wider trading range.
"Therefore, interest rate arbitrage will likely become more active only when the exchange rate gets closer to the upper limit, or to the lower limit in the event of devaluation speculation," said George Leung, chief economist at HSBC.
The first test of the band's resilience is expected to come from a renewed burst of speculation of the yuan, or even an actual shift in Chinese currency policy.
Arbitrage activity could be intense, mopping up excess liquidity and boosting trading volumes, but analysts expect the Hong Kong dollar's upside cap will hold.
Until then, dealers will have plenty of spare moments to try and think of new ways to generate business.
REUTERS
Susan Fenton
June 16, 2005
For the first time in nearly 22 years, dealers in Hong Kong know where the buck stops - but they're not ready to trade it.
Authorities last month made a historic change to the Hong Kong dollar peg, creating a ceiling for the first time and lowering its long-standing floor.
The move, designed to curb pressure from hot money flows on speculation that Hong Kong would follow a revaluation of the yuan, established a 1.3 percent band of 7.75 to 7.85 per US dollar in which the currency can now trade.
But dealers say the market has lost vigor and it will take time before a genuine market develops based on views about the Hong Kong dollar and economy, as opposed to flows from exports, imports and investments.
"Officially the band has widened but you need a reason to trade," said Carlos Cheung, chief foreign exchange dealer at Bank of East Asia.
"Now there's no volatility, so no matter whether you buy or sell the Hong Kong dollar, it won't move."
So far this month the Hong Kong dollar has been stuck between 7.7730 and 7.7855 per dollar.
It will take heavy fund flows to push it up to 7.75 and the only likely catalyst for that in the current environment is speculation on the yuan.
In theory, dealers could have traded the Hong Kong dollar more actively previously, because there was no defined ceiling.
The peg was introduced in 1983 amid a crisis of confidence about Hong Kong's future given the then-British colony was to be handed over to China in 1997. The floor gave the market certainty, while there was no need for a ceiling.
"Ten to 15 years ago the Hong Kong dollar moved in a very narrow range," said Dennis Wong, chief foreign exchange dealer at Hang Seng Bank.
"Hong Kong's future post-1997 drove the market but only for a short while: the Hong Kong dollar was going down but due to the peg it could only go to 7.8 so there was not much activity."
Speculation of a change had dominated Hong Kong dollar trade since late 2002, when markets began to aggressively bet on a revaluation of the yuan.
At first, there was speculation Hong Kong would devalue and traders positioned for a convergence with the yuan. But from late 2003, the speculation changed to a Hong Kong dollar revaluation and the currency strengthened. The ceiling changes that.
"It's certainly killed some people's idea of wanting to speculate on the yuan via the Hong Kong dollar," said James Malcolm, currency strategist at Deutsche Bank.
The forwards market has been hit by reduced speculative flows and spot trade is lackluster, contrary to some analysts' expectations that a wider trading band would ignite the market.
Data from the Bank of International Settlements shows the Hong Kong dollar market is the biggest in Asia after the Japanese yen and Australian dollar.
Hong Kong dollar turnover in spot, outright forwards and foreign exchange swaps averaged US$33.2 billion a day in April 2004, almost double that for the Singapore dollar, said the BIS.
Trading volume in the Hong Kong dollar hit a record high May 18 on news of the changes, up nearly eight-fold from the 2005 daily average, as speculators took flight, data showed.
Since then volumes have slipped below this year's average, according to market players.
The currency has yet to test its cap and has been swayed by genuine capital flows in and out of the territory.
Wong thinks that with time, the market will develop.
"There will be more volatility because the band is wider so there is more room for movement in the spot rate. But there is no news to stimulate the market," he said.
"Players need to get used to the new measures. They are just waiting to see what happens. There are no big positions in the market."
The new band does increase the attractiveness of arbitrage trade - the exchange of Hong Kong for US dollars or vice versa to benefit from widening spreads between US and Hong Kong interest rates, but only at its boundaries.
In the middle of the band, currency risk is greater than before because of the wider trading range.
"Therefore, interest rate arbitrage will likely become more active only when the exchange rate gets closer to the upper limit, or to the lower limit in the event of devaluation speculation," said George Leung, chief economist at HSBC.
The first test of the band's resilience is expected to come from a renewed burst of speculation of the yuan, or even an actual shift in Chinese currency policy.
Arbitrage activity could be intense, mopping up excess liquidity and boosting trading volumes, but analysts expect the Hong Kong dollar's upside cap will hold.
Until then, dealers will have plenty of spare moments to try and think of new ways to generate business.
REUTERS