Hi Paul,
Thanks for continuing the discussion. I don't like posting entire articles, however, I'll take the risk this time:
Hedge Funds Still Target
Hong Kong Dollar Peg
By ERIK GUYOT
Staff Reporter of THE WALL STREET JOURNAL
HONG KONG -- The stock market continued to rally in the
belief the government is buying stocks to drive currency
speculators out of the financial markets.
But it may be only a temporary respite. Hong Kong's
economy still is worsening; the stock market hit a five-year
low last week, and betting against the Hong Kong dollar is a
cheap and easy wager for speculators.
The benchmark Hang Seng Index rose 1.6%, or 119.95
points, to 7742.53 Thursday, and has jumped 16% in the
week since the government last Friday began for the first time
buying stocks to prevent speculators from what it calls
"manipulating" the Hong Kong dollar to reap profits in the
stock market.
Bid to Limit Losses
The government wouldn't confirm it was buying stocks
Thursday, but traders attributed the rise to government buying
and to speculators scrambling to cut their losses by buying
and replacing stocks they had borrowed and sold in
anticipation of those stocks falling.
With the speculators supposedly at bay, even smaller stocks,
which had recently lagged the benchmark index, rose. Red
chips -- shares in Hong Kong companies with mainland
Chinese parents -- jumped 5.9%. Class H shares in companies
incorporated in mainland China leapt 6.3%. And an index of
50 midsize companies rose 2%.
While some speculators are fleeing, a number of analysts said
the government's action is only likely to encourage more
attacks in the long run. "Stay short all Hong Kong assets,"
recommended David Roche, president of London-based
Independent Strategy Ltd., in a fax Monday to hedge-fund
clients.
Currency Speculators Targeted
The government maintains that big hedge funds that wager
huge sums in global markets had been scooping up big profits
by attacking both the Hong Kong dollar and the stock market.
In a speech Thursday, Hong Kong Chief Executive Tung
Chee Hwa said the government intervened in the stock
market only to foil these speculators, not to prop up a market
that has fallen by more than half in the past year. The
government doesn't oppose investors who are short-selling
only stocks, he said. Mr. Tung also acknowledged for the first
time that the city is heading into recession.
Under this city's pegged-currency system, when speculators
attack the Hong Kong dollar by selling it, that automatically
boosts interest rates. Higher rates lure more investors to park
their money in Hong Kong, boosting the currency. But they
also slam the stock market because rising rates hurt
companies' ability to borrow and expand.
Speculators make money in a falling stock market by
short-selling shares -- selling borrowed shares in expectation
that their price will fall and that the shares can be replaced
more cheaply. The difference is the short-seller's profit.
Local Dollar 'Overvalued'
"A lot of hedge funds which operate independently happen to
believe that the Hong Kong dollar is overvalued" relative to
the weak economy and to other Asian currencies, said Bill
Kaye, managing director of hedge-fund outfit Pacific Group
Ltd. Mr. Kaye points to Singapore where, because of the
Singapore dollar's depreciation in the past year, office rents
are now 30% cheaper than they are in Hong Kong, increasing
the pressure on Hong Kong to let its currency fall so it can
remain competitive.
Hedge funds, meanwhile, "are willing to take the risk they
could lose money for some period," he said, while they bet
Hong Kong will drop its 15-year-old policy of pegging the
local currency at 7.80 Hong Kong dollars to the U.S. dollar.
These funds believe they can wager hundreds of millions of
U.S. dollars with relatively little risk. Here's why: If a hedge
fund bets the Hong Kong dollar will be toppled from its peg,
it's a one-way bet, according to managers of such funds.
That's because if the local dollar is dislodged from its peg, it is
likely only to fall. And the only risk to hedge funds is that the
peg remains, in which case they would lose only their initial
cost of entering the trade to sell Hong Kong dollars in the
future through forward contracts.
Relatively Low Cost
That cost can be low, permitting a hedge fund to eat a loss
and make the same bet all over again. When a hedge fund
enters a contract to sell Hong Kong dollars in, say, a year's
time, it is committed to buying Hong Kong dollars to
exchange for U.S. dollars in 12 months. If the currency peg
holds, the cost of replacing the Hong Kong dollars it has sold
is essentially the difference in 12-month interest rates between
the U.S. and Hong Kong.
On Thursday, that difference in interbank interest rates was
about 6.3 percentage points. So a fund manager making a
US$1 million bet Thursday against the Hong Kong dollar
would have paid 6.3%, or US$63,000.
Whether a fund manager wanted to make that trade depends
on the odds he assigned to the likelihood of the Hong Kong
dollar being knocked off its peg and how much he expected it
then to depreciate.
Odds May Favor Gamble
If he believed the peg would depreciate about 30%, as a
number of hedge-fund managers do, then it would have made
sense to enter the trade if he thought there was a one-in-four
chance of the peg going in a year. That's because the cost of
making the trade -- US$63,000 -- is less than one-fourth of
the potential profit of a 30% depreciation, or US$300,000.
For those who believe the peg might go, "it's a pretty good
trade," said Mr. Kaye, the hedge-fund manager. He said that
in recent months he hasn't shorted Hong Kong stocks or the
currency.
With those kind of odds, the big global hedge funds are likely
to be back, said Henry Lee, managing director of Hendale
Group Ltd., a Hong Kong-based hedge fund.
Wading into the stock market with government buying won't
hold it up forever, and could even instigate more attacks as
hedge funds perceive the government can't tolerate the
political fallout from higher interest rates.
"There's a feeling [the government has] beaten back the
speculators," Mr. Lee said, "but the problem is they've
become one in the process."
Mr. Lee said that the stock market probably will remain
buoyant for several months, but that "after that, it's anybody's
guess. The Hong Kong Monetary Authority can't defy market
forces forever."
--Jon E. Hilsenrath and Yu Wong contributed to this article. |
