Money Trouble: An Asian Currency Opportunity

And then there’s the fact that, quite simply, pegs don’t work in the long run. Consider what happened with the Argentine peso It was pegged to the USD until the country’s horrific crash in 2001 and the overnight decision to convert all savings accounts in dollars back into pesos at a new, much worse rate, a disaster for its citizens. The euro, a currency in distress because of troubling political and fiscal inputs from its members, is effectively a peg. Its traumas play out on the front pages, though the political reasons behind them are more powerful than in Hong Kong. It’s true that if you’re a commodity producer looking for credibility for your central bank, a peg to the dollar may make sense — at least until the market for that commodity collapses. Witness the pain being felt throughout dollar-pegged oil producers: Nigeria has been forced to depreciate its naira almost 20 percent against the dollar since last June; Saudi Arabia, whose riyal has had a bumpy autumn, though the pressure against it is cushioned by the Kingdom’s vast currency reserves; Venezuela, where the usual schizophrenic divide between the official peg and black-market rates has been exacerbated. More importantly, this summer shows that Asian pegged currencies are indeed vulnerable to Chinese economic tremors: Vietnam moved the dong’s USD peg and Kazakhstan de-pegged the tenge entirely from the USD, all in the aftermath of the renminbi devaluation (both look like competitive devalutations).

Whether the forces of inertia triumph over the increasingly troubled economic realities in the region and worldwide is, as noted, a tough call; hedging a move or a break may be hedging an event that never occurs. But the truly attractive part of this play is that it is not necessary to be able to intuit whatever Mr. Chan and his colleagues at the central bank and their ultimate masters in Beijing may have planned — it’s enough to know that the HKMA will most certainly not revalue the HKD higher against the dollar.

There are two real possibilities here. The first is a peg with the renminbi. Should the PBOC devise a new scheme for greater prosperity that involves such a re-pegging, we predict the result will be a weakening: it’s hard to see China letting the HKD trade at its current rates with the yuan, which would represent a significant appreciation. The Xi government will let the HKD weaken. If the current macro trends continue in China, so too will that weakening — and if there are any further jolts or shocks, it will be accelerated. Should the city’s monetary masterminds float the currency, the central prop in the HKD’s attractiveness as a safe haven vanishes. The bottom then becomes much harder to predict. Consider the tenge, which has gone down almost 63 percent against the USD since its peg broke.

The unease around the HKD has quieted for the moment and will likely stay quiet until China makes another dramatic economic move. But even under the more conservative first scenario, investors can profit massively. Volume may be low here, but through leverage in the options market you can multiply your winnings — leverage that in this case carries almost no downside risk: remember, none of the political powers with control of the printing presses is going to let the HKD slide higher against the dollar than it already has.

The options market in the HKD trembles in sync with Chinese instability. In the days and weeks after the renminbi devaluation, the implied one-year volatility of the HKD — an effective proxy for options pricing — jumped to 3.2 percent, its highest level since 2004 and a more than tripling of its level prior to the devaluation. This shows that there is strong if sublimated sentiment in the markets against the peg as well, a recognition of the factors that make the peg long-term unsustainable.

So it may not move at all, but if it does move there is nowhere for the HKD to go against the dollar but down.