Nomura – HKD: Reasons why we expect the peg to stay

Another area of focus in Asia is the USD/HKD peg following spot trading at 7.7498 on 25 March – below the strong side convertibility undertaking rate of 7.750. We think this is a one-off and expect no near-term change in the peg for the following reasons:

1. The recent strength is related to large inflows from a rights issue as well as broad USD weakness. We expect the former to be temporary.

2. We do not see this move in spot as a sign of HKMA testing the market reaction to a possible change in regime. Spot has previously tested below 7.750 on a few occasions (in November and December 2008).

3. In November and December 2008, the HKMA intervened significantly by injecting HKD into the money market. An extreme example is in September 2003 (although there was no strong side convertibility rate) when spot fell to a low of 7.71 before massive HKMA intervention. The HKMA had unofficially kept spot in the 7.79-7.80 range from August 2000 to September 2003.

Given the magnitude of recent intervention to support spot USD/HKD (total HK$32.5bn injection since 20 March), it is clear that the authorities want to maintain the USD/HKD peg and convertibility undertaking rates. However, these large injections may lead to lower HKD rates and forward rates.

4. Aside from the HKMA’s action in the market, we also do not consider this a good time to make such a profound change in monetary regime. The weakness in the global economy and volatility in financial markets would likely lead investors to demand a risk premium on HKD if there were a change in policy.

5. We see the current situation of a weaker HKD and zero interest rates as supportive of the economy.

6. The alternatives also look limited with the consensus expectation of HKD pegging against the CNY still an event for the coming years rather than in the coming months given the limited CNY convertibility.

7. Beyond CNY convertibility, we think it will be sensible for HKD to peg to the CNY only if China’s financial institutions are strengthened and China’s management of monetary policy becomes effective and prudent.

8. There may also be limited scope for a near-term change as the instigators of the USD/HKD peg are still some of the front-line decision makers. Until there is a change in leadership, the USD/HKD peg is likely to still be viewed as the best policy.