(Bloomberg) -- A stunning rally in the Hong Kong dollar is unraveling quickly, with the currency sliding for a second day and moving back toward the weak half of its trading band.
The exchange rate dropped to as low as 7.7998 per greenback, near the midpoint of 7.8 in its allowed trading range. The pullback in the Hong Kong dollar followed a seven-day advance, which this week made the currency the most overbought in more than a year, according to its relative strength index.
The adjustment isn’t surprising as market watchers thought the rally would prove short-lived. The ascent was mostly triggered by transitory factors, such as bets that liquidity will tighten toward year-end with banks hoarding funds for regulatory checks. Also, stronger risk appetite that’s been helping Hong Kong assets may not last, as the China-U.S. trade war is expected drag on next year.
Longest Hong Kong Dollar Rally in Eight Years Is Burning Shorts
But that doesn’t mean the Hong Kong dollar will fall all the way back to the weak end of its trading band. That’s because local interbank interest rates have stayed higher than funding costs in greenbacks since November, outstripping the income a trader can expect on U.S. dollars. Therefore, the short carry trade -- where investors sell the Hong Kong dollar and buy greenbacks -- won’t become popular anytime soon.
The currency’s one-month interbank borrowing costs are 78 basis points higher than similar rates on the greenback. That’s close to the highest since the 1990s.
That short strategy repeatedly helped push the Hong Kong dollar to the weak end of the band, triggering official intervention. The city’s interbank liquidity pool shrank by 70% since April 2018 as the de-facto central bank bought back local dollars to defend the peg to the greenback.
As of 10:34 a.m. local time, the Hong Kong dollar weakened 0.07% to 7.7995 per greenback.
