One of the most popular money-making trades in global finance this year — borrowing Hong Kong dollars cheaply and investing the proceeds in higher-yielding U.S. dollar assets — is losing its appeal as borrowing costs in Hong Kong rise, according to a report published Tuesday by Bloomberg News reporters Iris Ouyang and Jacob Gu. The shift reflects changes in Hong Kong’s financial system that are making the trade more expensive to maintain.
Here is the trade in simple terms. For much of this year, Hong Kong dollars were relatively inexpensive to borrow. Traders took advantage by borrowing Hong Kong dollars at low rates and moving the money into U.S. dollar assets offering higher returns. The difference between the borrowing cost and the investment return is known as a carry trade.
The attraction of the strategy depends on one key factor: cheap funding. As long as borrowing costs remain low, traders can earn the spread between the two currencies. When funding costs rise, that profit margin shrinks.
The benchmark at the center of the story is HIBOR, the Hong Kong Interbank Offered Rate, which measures the rate banks charge one another to lend Hong Kong dollars. As HIBOR increases, the cost of financing carry-trade positions rises as well.
The reason traces back to Hong Kong’s currency system. Since 1983, the Hong Kong dollar has been pegged to the U.S. dollar within a trading band of HK$7.75 to HK$7.85 per U.S. dollar. When the currency weakens toward the lower end of that range, the Hong Kong Monetary Authority (HKMA) intervenes by purchasing Hong Kong dollars from the market.
Those interventions remove liquidity from the banking system. With less cash available, short-term borrowing costs tend to increase. In effect, the same market forces that encouraged the carry trade have also contributed to the conditions making it less profitable.
Seasonal factors are adding pressure. Midyear is traditionally a period when large dividend payments, corporate funding needs, and new stock offerings absorb liquidity from Hong Kong’s financial system. That can further tighten money-market conditions and contribute to higher borrowing rates.
The implications extend beyond hedge funds and currency traders. Most residential mortgages in Hong Kong are linked directly or indirectly to HIBOR. As the benchmark rises, mortgage payments can increase, affecting household budgets across the city.
Banks often benefit from a higher-rate environment because they can earn more on loans and other interest-bearing assets. Borrowers, however, face higher financing costs. Property developers, homebuyers, and businesses seeking credit may all feel the effects if funding costs continue climbing.
For savers, the picture is somewhat brighter. Higher interest rates can lead to improved returns on bank deposits and savings products, though those gains often lag changes in wholesale funding markets.
Importantly, the recent rise in borrowing costs is not viewed as a threat to Hong Kong’s currency peg. Rather, many analysts see it as evidence that the system is functioning as intended. The peg relies on automatic adjustments in liquidity and interest rates to keep the currency within its designated trading range.
The broader question for investors is whether the narrowing gap between Hong Kong and U.S. funding costs will continue. If borrowing Hong Kong dollars becomes significantly more expensive, the economics that fueled the carry trade could weaken further.
For now, the takeaway is straightforward: the era of exceptionally cheap Hong Kong dollar funding appears to be fading, reducing the attractiveness of one of the market’s most widely used currency trades.
JBizNews Desk — Asia
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