Hong Kong dollar forward points

inSight

24 Oct 2002

Hong Kong dollar forward points

A rise in the one-year forward on the Hong Kong dollar reflects concerns about the economy, but what we are seeing may well be a seasonal phenomenon.

There seems to be quite a lot of press interest recently in the movements of the exchange rate in the forward market. This is understandable, given widespread concern that the general economic health of Hong Kong and the specific problem of the budget deficit may, sooner or later, impact upon exchange rate stability. But, as I pointed out last week, very much as an attempt to provide a counter-balance to the rather nervous sentiment, the very healthy external financial position of Hong Kong continues to underpin the stability of our currency. Any talk of the Link not holding is, I think, premature, to say the least.

It is a fact, nevertheless, that, to use market jargon, the one-year forward has risen sharply in recent weeks. From around 50 pips in the middle of the year, it rose to 370 pips and then declined to about 300 pips earlier this week. The rise for the two-year and three-year forwards has been even greater, although I understand from those close to the market that trading has been rather thin in the long-dated forwards. But the market for the one-year forward is a reasonably active one, and so the sharp rise can be considered to be an accurate reflection of market sentiment.

The numbers should be interpreted very carefully. A five- to sixfold increase is of course large, but we are talking about 300 pips on an exchange rate of 7.8000. This is about 0.4 per cent. It means that there are people who are currently prepared to buy or sell Hong Kong dollars against US dollars, for delivery in a year's time, at 7.83. The intention behind these deals can be for hedging exposures to the Hong Kong dollar or outright currency speculation. What the market is telling us is that there are people who are prepared to pay 3 cents as insurance, against the risk of the Hong Kong dollar depreciating to significantly above 7.80. By way of illustration, this would work out as a 3 per cent insurance premium in the event of a one-dollar depreciation, 1.5 per cent insurance premium in the event of a two-dollar depreciation, 0.75 per cent insurance premium in the event a four-dollar depreciation, and so on. But there are also people who are prepared to pocket those insurance premiums. To simplify even further, this correspondingly means bets of 33 to 1, 66 to 1 and 133 to 1, and there are people who are prepared to accept those bets. (As a former Steward of the Hong Kong Jockey Club, let me tender some horse-betting advice. For horses with whatever odds, my recollection is that the chances of their winning, measured by the number of wins to the number of races with horses starting with those odds, are a lot less than the odds.)

If we look at the movements of the one-year forward at about the same time last year, we see a similar sharp increase in October, arising also from concerns about the budget deficit. It was then on an increasing trend until budget day, beyond which it came down as sharply as it went up. It is likely that what we are seeing now is a seasonal phenomenon, which will most probably go away with the emergence of a credible budgetary strategy, which I am sure the Financial Secretary will disclose on budget day.

 

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Joseph Yam

24 October 2002

 

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