Hong Kong Dollar Peg Under Pressure as Carry Trades Return

Rate Gaps, Peg Pressure, and the Return of the Carry Trade

• The Hong Kong Monetary Authority stepped in again this week to stop the Hong Kong dollar from slipping past its lower limit, selling US dollars as USD/HKD edged towards 7.85. It’s the clearest sign yet that pressure is building on the peg, with carry trades unwinding and liquidity conditions becoming more strained.

• There is a clear rate gap. US interest rates are still much higher than Hong Kong’s, and local HIBOR has dropped close to zero with plenty of cash in the system and weak loan demand. That gap has turned the Hong Kong dollar into a funding currency, one that investors borrow to buy higher-yielding US assets. Hedge funds and fast-money accounts, many of whom cut these trades back in May during the USD/Asia sell-off, are now stepping back in. Dealers are reporting more interest as the carry has become attractive again.

• But it’s not risk-free. Because Hong Kong runs a currency peg, the exchange rate can’t move to absorb the pressure like in other places. Instead, the strain shows up in local liquidity, bank balance sheets, and funding markets. The peg is holding for now, but stress is clearly building up.

• Things have started to settle into a pattern. HKD carry trades had a strong run through 2023 and early 2024, but we’re likely now in the late stages of that cycle. Volatility is rising, returns are getting squeezed, and the risks are starting to look mispriced. A break in the peg is still not the market’s base case, but rising liquidity stress, falling reserves, and tighter capital flows mean it can’t be ruled out entirely.

• The peg also makes the system more cyclical. As the rate gap widens, liquidity keeps tightening, local real rates fall deeper into negative territory, and asset returns suffer. Each time the HKMA intervenes, it uses up more reserves, slowly weakening the buffer that supports the peg. If this continues, it leaves less room for policy to deal with shocks, especially if the Fed stays on hold while Hong Kong’s economy continues to soften.

Our View at Cordoba

• We see this as a classic case of stressed carry conditions. The reward for holding HKD assets just isn’t worth the risk anymore, especially when you adjust for volatility that’s being priced too cheaply. The real point here isn’t whether the peg holds or not, it’s how much risk quietly builds up when policy frameworks become uncertain. Right now, global rate cycles are misaligned, safe assets are scarce, and capital can’t flow as freely as models assume. That changes how the trade behaves.

• We’re not positioning for a hard break in the peg. But we are actively tracking where pricing has become inefficient. HKD assets with long duration are vulnerable, not because of credit risk, but because of the convexity that emerges when markets reprice regime uncertainty. For sovereign investors, this means pulling back from stretched HKD carry trades, avoiding short-vol bets in pegged currencies, and stress-testing funding legs that rely on persistently loose conditions.

• What’s happening here is part of a wider pattern we’ve been watching. Policy constraints, things like currency pegs, capital controls, and yield suppression, are becoming more central to how markets work, which we can’t simply ignore. They’re reshaping how carry trades behave and where the risks really are. To manage that properly, you need to understand where these pressure points are building before, they become a problem.