Forex Investment and Currency Trading

Hong Kong initiated its present currency board and peg to USD in October 1983 – a period of volatility in local markets sparked by Sino-British negotiations on the territory’s reversion. The Hong Kong dollar had floated freely between 1974 and 1983, and before then was pegged to GBP. Initially, its modern currency board operated in a strict, non-discretionary fashion, with periodic interventions mostly on the strong side as the USD slumped in the late 1980s. But over time, and particularly after the HKMA was launched in 1992, its operations became more complex. In March 1994 the HKMA announced that it would begin targeting the inter-bank rate (keeping it close to the US), which made its FX interventions more frequent whilst raising the suspicion that it was becoming less willing to defend the peg per se. To counter these concerns, the Authority gradually moved its market intervention rate down, establishing a “first line of defense” around 7.75. This level was defended aggressively during the Asian Financial Crisis, with USD sales and by the squeezing of liquidity to push the benchmark 1-year forward rate to several thousand pips into premium. After devaluation pressure subsided in late 1998 HKMA introduced “seven technical measures,” refining the system to reflect various lessons learned. These centred upon guaranteeing the USD value of bank’s clearing balances under a fixed rate Convertibility Undertaking (to reduce their FX risk), and allowing the use of Exchange Fund bills and notes as collateral for discount window borrowing (effectively doubling the monetary base). In April 1999 it then announced that the Convertibility Undertaking would be raised from 7.75 to 7.80 by one pip per day, recognizing that a broach of this “line of defence” so close to the official rate would also have guaranteed a break of the latter. The return to a less discretionary system was very much partial, as developments since 2003 have underlined. A strong rebound from SARS, considerable cyclical momentum, and a backdrop of high expectations for CNY revaluation prompted a bout of short-HKD position squaring among both speculators and hedgers in September that year, with spot falling to as low as 7.7050 (-1.2%) in the aftermath. In the context of continued CNY reval speculation, USD/HKD (spot and forwards) remained heavy, and on 18 May 2005 HKMA took steps again to shore up the peg. A strong-side convertibility undertaking was implemented at 7.75, and a symmetric weak-side limit set at 7.85.

HKMA also retains the discretion to intervene between these limits if circumstances are deemed to warrant it.