Hong Kong stocks were already showing signs of stress, losing more than 5% over the past week. Now, liquidity conditions in the foreign-exchange market are the tightest since the late 1990s, or the aftermath of the Asian financial crisis.
Interbank rates are climbing — making funding costs more expensive for banks — while a gauge of expected swings in the Hong Kong dollar is near its highest in a month.
The moves come as disruption hits a new level of intensity, with protesters paralysing the city with blockades and as tear gas swirls through the central business district.
The Hong Kong dollar briefly erased gains Thursday after the Global Times said in a since-deleted tweet that the government is expected to announce a curfew for the weekend.
With cash supply already under pressure due to demand for Alibaba Group Holding Ltd’s massive public offering and banks’ seasonal cash requirements, this week’s violence has revived concern that the protests could eventually lead to capital flight.
The city’s economy has crashed into recession, amid plummeting tourism and retail sales.
The evidence of outflows has so far been mostly reassuring. But a sustained flight could push the Hong Kong dollar weaker, prompting authorities to defend the currency’s peg to the greenback.
That would mop up more liquidity and send borrowing costs even higher, affecting everything from mortgage rates to corporate funding.
The Hong Kong dollar’s three-month forward points, an indicator of liquidity in the foreign-exchange market, soared to the highest level since September 1999 this week.
An increase in this gauge — resulting from a short-term drainage of cash — coupled with a weaker spot rate “signify an increase in risk-aversion to Hong Kong dollar assets,” Chun Him Cheung, a strategist at Morgan Stanley, writes in a note.
The three-month forward points jumped to 140, while the spot rate was little changed at 7.8277 per greenback as of 6pm local time.
The three-month interbank borrowing costs of the Hong Kong dollar are more than 40 basis points higher than the equivalent interest rates on the greenback.
That’s the widest spread since late 1999, suggesting that financing is increasingly expensive for local lenders. On the other hand, the gap makes it costly for traders to short the city’s currency.
Investors are also pricing in further tightness in the longer term. The cost of Hong Kong dollar 12-month interest-rate swaps, an indicator of traders’ bets on future liquidity in the interbank market, jumped this month to the highest level in nearly a year.
The Hong Kong dollar’s six-month implied volatility surged to the highest level since mid-October, suggesting traders are pricing in bigger swings in the currency.
Despite the cash squeeze, the Hong Kong dollar itself hasn’t touched the weak end of its trading band against the greenback since May.
Bolstering that resilience, according to OCBC Wing Hang Bank Ltd, is confidence that the city will remain a financial hub and what’s perceived to be a lack of massive outflows — for now.