The Hong Kong dollar peg is in danger

In 1997:

Hong Kong survived the attack on the linked exchange rate regime well because:

1. The economy boomed in the mainland.

2. China accumulated large amounts of FX reserves.

3. China supported the continued economic prosperity of Hong Kong.

4. China protected Hong Kong from the financial crisis.

In 2017:

Hong Kong is vulnerable to a financial crisis again, but this time is different because:

1. The economy is no longer booming in China.

2. There is increased capital outflow from Hong Kong and the mainland.

3. FX reserves are shrinking.

4. Hong Kong banks are accelerating their lending exposure to the mainland while China's strict capital control leads to shrinking liquidity in Hong Kong.

5. The asset price bubble results in the price inflation, which has impacted on trading and logistics.

6. Social disorder is affecting the tourism industry.

7. Financial services, tourism, trading and logistics are no longer the driving force of Hong Kong’s economic growth.

​8. The HKD depends heavily on the China's economy.

HIBOR and LIBOR Comparison as of 4-Aug-2017

It is found that for 1-month interbank offered rate, the spread is 1.22889%-0.42886%=0.8%.

Large spread means capital outflow because ALL capital flows into where there is profit.​

1 Year Bond Yield Comparison as of 12-Aug-2017

Source: investing.com

The 1-year bond yields are 1.2% and 0.59% for US and Hong Kong respectively. Because HKD is currently pegged with USD, this is an arbitrage opportunity.

HIBOR and SHIBOR Comparison as of 12-Aug-2017

HIBOR is a lot lower than SHIBOR.

The low-interest rate drives HKD to China, which becomes part of the forex reserve.

How much money has flowed to China from Hong Kong?

3.8 trillion dollars, which is an increase of 6.73% (YOY)

Source: Hong Kong Monetary Authority

Final Words

Further HKD depreciation requires HKMA to sell USD and buy HKD, which results in HIBOR increase.

Higher HIBOR means increasing the burden of mortgagor as well as pressure on the capital chain.

That HKD pegging with USD under a worsening Chinese economy and the upcoming shrinkage of the Fed's balance sheet is unsustainable.

The Swiss National Bank broke its promises of Swiss peg in 2015 and Hong Kong Monetary Authority is going to share the same destiny.

Let's wait and see.

USD/HKD Exchange rate as of 5-Aug-2017