Asia in Focus:HKD defying gravity?Smooth rates catch-up vs.risk of sharper move down the road

We have long expected USD/HKD to hit the weak side of n the HKD band (7.85)and Hong Kong interest rates (HIBORs) to catch up to USD LIBORs as the Fedtightens. We continue to hold this view as our modal forecast.

    The band arrangement of the currency peg and market friction make thelikelihood and timing of HKD and HIBOR adjustment uncertain. But we believe itis likelier than not that capital outflows driven by interest rate differential will pushUSD/HKD to 7.85 before too long after the Fed hikes again (expected for theforthcoming FOMC meeting).

    From an economic standpoint, we see it as preferable for HK rates to catch up toUSD LIBORs when the interest rate differential is still relatively small. A delayedadjustment could imply a sharper rate move and a larger shock to HK growth andasset markets when the correction finally comes.