“That’s a nuclear option — it’s unlikely but not impossible”.
“[It] sounds quite radical and will have profound and unpredictable implications not only for China’s banks, but also the US banks and the global financial market”.
“It’s a fairly wacky idea”.
Those soundbites (from economists and traders) give you the flavor of the market’s reaction to news that aides and advisers to Mike Pompeo have floated the idea of undermining the Hong Kong dollar peg as a way of punishing China for the imposition of strict new national security laws in the city.
In short, the market thinks it’s ill-advised, but also profoundly stupid, not to mention self-defeating to the extent it would undercut the US dollar’s credibility and reduce the number of USD transactions given Hong Kong’s status as a major international dollar-trading hub. It’s also not clear it would even work (figure below).
Nevertheless, an attempt to cut Hong Kong off from the USD would effectively mean the end of HKD eventually, irrespective of whether the peg could be technically defended for a time and notwithstanding the myriad logistical nightmares for the US of imposing the necessary restrictions.
Targeting HSBC and Standard Chartered for supporting the new national security law would make more sense for the US, which is why shares sank Wednesday in the wake of the peg chatter. Mike Pompeo recently ridiculed HSBC.
“The US clearing license is vital to HSBC’s global operations and the bank is one of the largest international lenders operating in America”, Bloomberg reminds you. “HSBC is also the largest note-issuing bank in Hong Kong, putting it at more risk than Standard Chartered… should the US limit their ability to buy dollars”.
In any event, the HKD rumor mill wasn’t enough to dent sentiment in mainland Chinese shares, which powered ahead for a seventh session. The recent rally has pushed local equities to some of the most overbought levels since the halcyon days of early 2015, conjuring comparisons to that year’s bubble (and subsequent collapse).
In a testament to — I don’t know, something — Hong Kong shares managed to gain as well, rising despite the geopolitical overhang.
“Yes, this is only some members, and neither Pompeo nor President Trump have yet been given the option to approve”, Rabobank’s Michael Every said of the peg idea.
“However, this is a nuclear bomb being assembled on the table in front of us pointed directly at Hong Kong and US-China relations and the reaction in the Hang Seng today was to rise”, Every went on to marvel. “How can this be the case?”, he wondered. “Because we have post-modern markets. Don’t like facts? Ignore them [and] buy more assets!”
He is, of course, being sarcastic.