Instant Thoughts. Ryan Lam, CFA. 13 April HKD in the Crosshairs. Head of Research

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Ryan Lam, CFA Head of Research ryan.lam@shacombank.com.hk +852 2841 5283 Instant Thoughts 13 April 2018 HKD in the Crosshairs In this note we clear up some commonly-cited misconceptions.

FX conversion, even at the weak-side Convertibility Undertaking, will not be automatically reflected in the Aggregate Balance. Capital outflows occurred well before 7.85 is reached. A leap from 7.

1 Ryan Lam, CFA Head of Research Instant Thoughts 13 April 2018 HKD in the Crosshairs In this note we clear up some commonly-cited misconceptions. Only when private sector sidelined and satiated will the HKMA provide the liquidity to the banking system. FX conversion, even at the weak-side Convertibility Undertaking, will not be automatically reflected in the Aggregate Balance. Capital outflows occurred well before 7.85 is reached. A leap from to 7.85 tells us nothing more than what we already knew. One shall not expect an immediate lift-off in HIBOR. The Aggregate Balance now stands at an eye-popping level of HKD176.5 billion. Taking a page from the previous episodes, it would take 27 consecutive days of intervention to bring the Aggregate Balance back to HKD20 billion. We feel confident that the HKD rates will spike only until the 3Q18. We expect 1-month HIBOR to reach 1.6% by the end of A pips-wide deviation from 7.85 shall not spook the market, as long as the deviation is within the range of regular bid-ask spread. The USD/HKD could turn south in the absence of positive carry. We sense that a wave of long USD position was initiated between Once the carry becomes less-than-juicy, they would waste no time in offloading their dollar holdings. Despite the biddish tone for Asian currencies was set early by President Xi s conciliatory remarks, the HKD bucked the trend. The USD/HKD touched 7.85 briefly yesterday, the first time since the establishment of the convertibility zone in It is human nature to use heuristics in interpreting unprecedented events, and sadly, that s bound to create misconceptions. In this note we clear up few commonly-cited misconceptions.

2 Misconception 1: HKMA has legal obligation to pick up all orders at 7.85 HKMA should be seen as a buyer of the last resort of the HKD. Only when private sector sidelined and satiated will the HKMA provide the lifeline to the banking system. The HKMA did purchase HKD3.26 billion of HKD last night. Bear in mind, the creation of convertibility zone per se serves the purpose of lifting the HKMA from the day-to-day burden of being a part of the first line of defense. Consequently, FX conversion, even at the weak-side Convertibility Undertaking, will NOT be automatically reflected in the Aggregate Balance the clearing account maintained by private banks with the HKMA. Misconception 2: Capital outflows set to worsen after hitting 7.85 Capital outflows occurred well before 7.85 is reached. A leap from to 7.85 tells us nothing more than what we already knew. What makes 7.85 a magic number is not that there is a seismic shift in sentiment, but that it represents a permanent liquidity drainage. Within the trading band between 7.75 and 7.85, any HKD-selling orders will have to be settled among banks. Money just move from one pocket to another, leaving the total liquidity intact. As always, things go wild in extreme setting. At 7.85, the liquidity would flow out of the banking system when HKMA steps in to defend the currency band. This binary outcome is set by design. Misconception 3: We can expect an immediate lift-off in HIBOR Interest rate for the HKD will stay subdued unless banks run out of money. Versed in liquidity management, bankers stash their idle funds under the mattress, with the HKMA serving as their joint custodian. This sum is well known as the Aggregate Balance. The Aggregate Balance now stands at an eye-popping level of HKD176.5 billion. The million-dollar question is: When will the liquidity pool dry out? The size of daily intervention averaged HKD2.4 billion during Direct comparison is misleading though, as the current FX turnover is about 2.5 times than that of Taking that into account, it would take 27 consecutive days of intervention to bring the Aggregate Balance back to HKD20 billion, a level we deemed as a normal level. Taking a page from the previous episodes, the HKMA is not likely to step in every day. So getting there is no cakewalk. We feel confident that the HKD rates will spike only until the 3Q18. 1-month HIBOR is expected to reach 1.6% by the end of 2018.

3 Misconception 4: Any upside deviation from 7.85 is an ominous sign A pips-wide gap shall not spook the market, as long as the gap is within the range of regular bid-ask spread. It makes financial sense for offering banks to just cover their operational cost, precisely because they think that the risk of de-peg is limited. Misconception 5: HKD will be drawn to 7.85 like a metal to a magnet in the absence of positive carry Give it a second thought because of the positioning. We sense that a wave of long USD position was initiated between But these investors do not go into the battlefield cold. They did have a target return in the back of their minds. Once the carry becomes less-than-juicy, they would waste no time in offloading their dollar holdings. Driven by position liquidation, it is plausible for the USD/HKD to turn south even if HKD rates stay persistently below US rates.

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Instant Thoughts. Ryan Lam, CFA. 18 April PBoC s Ambush Rattled the Market. Head of Research

Instant Thoughts. Ryan Lam, CFA. 18 April PBoC s Ambush Rattled the Market. Head of Research Ryan Lam, CFA Head of Research ryan.lam@shacombank.com.hk +852 2841 5283 Instant Thoughts 18 April 2018 PBoC s Ambush Rattled the Market The People s Bank of China announced a reduction of 1ppt in required