Goldman: HKD Peg Likely To Hold Despite U.S. Rate Hiking Cycle

Goldman Sachs note that “the HKD and its link to the U.S. dollar have come back into investor focus recently. As the currency touched the weak-side of its convertibility zone (7.75-7.85 band vs. USD) five times in the past few days, the HKMA sold USD to purchase HK$17.6 billion from the market. In light of the fastest pace of Federal Reserve rate hikes in decades on the one hand, and a still sluggish Hong Kong economy on the other, some investors have questioned whether the HKD peg can be sustained.”

• “In our view the linked exchange rate system remains highly credible, even on the back of rising interest rates and weak mainland China and HK economic growth under the zero-Covid policy. With sufficiently large FX reserves (around US$430bn as of April 2022, 1.7 times the monetary base), HKMA has both the capacity and the demonstrated willingness to defend its linked exchange rate system. Additionally, mainland China and Hong Kong economic growth is likely to rebound in the coming months as Covid situations improve.”
• “Given the rapid Fed rate hikes expected by the market in 2022 and the widening of LIBOR-HIBOR spreads, USD/HKD could touch the weak side of the band repeatedly as we saw in 2018, and we think the upside to HIBOR could be meaningful. We expect a two-quarter lag between Fed rates move and the 1-month HIBOR rate move based on our analysis of previous Fed hiking cycles. HIBOR may start to experience more pronounced upward pressures when the aggregate balance of FX reserves falls to below HK$100bn, based on historical experience.”
• “Lastly, we look at the likely future of the exchange rate mechanism in Hong Kong. Each plausible alternative exchange rate regime has its drawbacks. A shift to peg to RMB could be a long-term possibility, preceded by more usage of RMB in Hong Kong and conditional on the progress of RMB internationalization. In the next several years, it seems to us that no other regime is obviously superior to the HKD peg currently in place.”