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HONG KONG DOLLAR PEG IN TROUBLE?

6 months ago I published research regarding a Hong Kong dollar peg trade. A currency peg is essentially  when currencies have a fixed exchange rate. The pound sterling devaluation in 1992 provides a comprehensive case study on currency controls gone array. Defending a peg can be really expensive when global interest rates are elevated. Another potential risk is political instability and the impact it has on the liquidity of a currency market. Now that Hong Kong and China are viewed as a single economic entity, the HKD is being lumped in with the Chinese Yuan. 

The Hong Kong China dispute is partially motivated by the intention of controlling and reducing capital outflows. Wealthy Chinese citizens have a growing suspicion and distrust of the CCP. The continuous covid lockdowns only further bolstered such sentiments. Money laundering has become a colossal issue for China. An estimated 2 trillion is laundered out of the country on an annual basis.  Hong Kong plays a pivotal role in the laundering of chinese wealth. 

The main thesis behind this idea is that the feds hawkishness creates a tricky situation for stabilizing an international currency.  Defending the hong kong dollars Peg against the US dollar is much more difficult without natural market liquidity. If the FX price drifts too far away from the target rate, the countries central bank needs to buy or sell it’s currency. Although Hong Kong has 400 billion in reserves, they spent $172 billion in one quarter defending the peg. Without a doubt de-pegging is a somewhat unlikely scenario. The main reasoning for taking this trade is that it presents a setup with asymmetric risk vs. reward. The worst case scenario is that the hong kong dollar peg is maintained. We are already familiar with the outcome of such events. The band trades in a defined range. Hong Kong Dollar derivative markets have much less liquidity than other major global currencies. 

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