Tariff Tracker, June 21: Hong Kong dollar declines, but investors wary of US assets

Dear reader,
Earlier this week, the US Federal Reserve announced it would hold interest rates steady for the fourth time in a row, with Chairman Jerome Powell saying it was too early to gauge the economic impact of tariffs.
The benchmark lending rate in the US has remained in the 4.25 to 4.5% range since January. While the fallout of the tariffs would logically translate into higher prices of goods, inflation rose marginally to 2.4% in May. The labour market has also remained stable. Economists anticipate that any Fed rate cut would be in response to rising unemployment, in what is described as a 'bad news rate cut'.
Powell also signalled the possibility of 'higher energy prices' because of Israel's war with Iran, adding that 'those things don't generally tend to have lasting effects on inflation.'
On Friday (June 20), the Hong Kong dollar (HKD) declined to the lower end of its trading range against the US Dollar (USD), trading briefly at 7.85 HKD for the first time since 2023. Given the current market volatility, market hawks have speculated whether the HKD's recent decline signals the end of this currency peg. The Financial Times columnist Robin Harding wrote on June 9 that the Hong Kong dollar slump was a 'warning light for global markets'.
To understand why this happened, we need to consider the unique exchange rate system in play. Since 1983, the Hong Kong dollar has been pegged to the US dollar ($1 = 7.80 HKD) in what is called a linked exchange rate system (LERS). The city-state's central banking authority, the Hong Kong Monetary Authority (HKMA), strictly maintains this exchange rate within the range of 7.75-7.85 HKD, and steps in whenever there is any risk of breaching the bounds.
When the HKD appreciates ($1 < 7.75 HKD), the HKMA buys USD reserves to restore the targeted rate by supplying the HKD.
Ahead of anticipated talks between the US and China towards a trade deal, as well as the prospect of a trade deal with Taiwan, Asian currencies rallied against the dollar as part of the Sell America wave, which we explained in the May 5 Tariff Tracker. In early May, the HKD value breached the 7.75 mark four times on three days, according to the HKMA. Thus, the authority sold HKD129.4 billion in exchange for USD16.7 billion, following the LERS mechanism. According to a Bloomberg report, this had been its first such intervention in five years – the HKMA in 2022 and 2023 moved to sell the USD when its currency was depreciating ($1 > 7.85 HKD).
The base rate set by the HKMA is also linked to the US Federal Reserve's policy moves. However, the gap between the HK base rate and US interbank rate has widened to its largest since 2018, Nikkei Asia reported. The Secured Overnight Financing Rate (SOFR), a US interbank benchmark rate, is currently in the 4.3% range, while the corresponding Hong Kong Interbank Offer Rate (HIBOR) is at about 0.5%, its lowest level in three years, the report said.
The HKMA's purchase of USD reserves increased liquidity in the market as HKD supply increased, and with it, interest rates in Hong Kong fell sharply. The HIBOR fell by about 3% since May 2, the Nikkei report said.
So what seems to be the problem?
The FT column expressed concern about how this interest rate gap has persisted, with no sign of letting up. Ordinarily, investors would respond to such a scenario by opting for a carry trade, in which they borrow funds at the lower interest rate and invest in the currency with the higher interest rate, to profit from the interest rate differences between the two countries (arbitrage).
This has thus far not happened. The fallout of US President Donald Trump's shifty tariff policies has resulted in a wider shift away from the US dollar. Since May 2025, Asian currencies, including the South Korean won, Japanese yen and Singapore dollar, have appreciated against the US dollar.
The FT report highlighted two major issues:
* One, the extreme caution taken by banks and hedge funds in responding to the arbitrage opportunity. Given the general back-and-forth on tariff announcements, these organisations have become risk-averse to the possibility of what could be considered 'easy money'.
* Two, a declining trust level in American assets by Asian investors. The FT report cited the contentious Section 899 of the One Big, Beautiful Bill, currently in US Congress, which threatens higher taxes on foreign investments. Even if this clause may not see the light of day, the general unpredictability has made potential investors wary.
What does this mean for Hong Kong?
Hong Kong authorities have welcomed the low interest rates, Nikkei Asia reported. Lower interest rates help to boost consumption spending and mean cheaper borrowing, especially on items like housing mortgages. Further, the downward trend in property prices, underway since 2021, may finally be arrested, with major local real estate companies already witnessing a recovery in their stock prices, the Nikkei report said.
However, this trend is likely temporary and would come to a halt once the HKMA intervenes to arrest the depreciating HKD value, which in turn would reduce liquidity and temporarily increase the HIBOR.
There are other factors at play as well. In its latest policy note on June 19, the HKMA noted that the HKD had been strengthening for months before the tariff announcements. The note drew attention to the 'buoyant capital market activities' by Chinese investors in the Hong Kong Stock Exchange, which helped its stock market index, the Hang Seng Index, gain 10% in the first four months. Further, dividend payments by listed companies in May and June also helped boost the HKD demand.
The HKMA has asserted that the LERS is working as it is expected to, and that the fluctuations in the HKD are all part of the system.

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