Are We Seeing the Death of Dollar Pegs?

More and more currencies pegged to the US dollar are coming under pressure. As speculators bet against the currencies of Saudi Arabia, Hong Kong and others, are we seeing the death of dollar pegs? Bloomberg Business says that in regard to bending dollar pegs, reserves keep them from breaking.

Countries with currencies pegged to the dollar are coming under increasing attacks by traders who bet it’s become too expensive for policy makers to continue defending exchange rates amid a soaring greenback and a collapse in commodities prices. It may be the speculators who end up losing.

It’s a tempting trade. Already, Kazakhstan, Azerbaijan and Argentina have been forced to devalue, and derivatives tied to the Saudi Arabia riyal and Hong Kong dollar suggest traders expect it won’t be long before the same happens to those currencies. Options prices put the odds of the Hong Kong dollar weakening beyond the weaker end of its current trading range this year at 36 percent, Bloomberg data show.

Together, Saudi Arabia and Hong Kong hold $1 trillion in foreign reserves, or enough to cover their imports and spending for years. Devaluations would only serve to destabilize their economies and could undermine Hong Kong’s status as Asia’s financial center, the analysts say. Hong Kong Monetary Authority Chief Executive Norman Chan on Monday reiterated his commitment to keeping the exchange rate’s existing link to the U.S. dollar.

But what if a nation does not have strong reserves? And what happens when reserves run out? Because low commodity prices are at the root of the pressure on pegged currencies, now long will oil and other commodities remain weak?

When Will the World Economy Revive?

The world economy is slowly weakening and taking commodity prices and currency values with it. The Washington Post reports the IMF downgrades its outlook for the world economy.

The International Monetary Fund on Tuesday lowered its forecast of global economic growth over the next two years amid the deepening slowdown in emerging markets and a continued slump in oil prices.

The IMF now projects the world economy will grow 3.4 percent this year and 3.6 percent in 2017. That pace would be faster than last year, but the projections are 0.2 percentage points lower than the IMF estimated in the fall – a sign that the global recovery is still struggling to build momentum.

China is expected to see its growth rate fall to 6.3% this year and 6% in 2017. Nations like Brazil that profit from seeing raw materials to China are suffering. Nations whose currencies are pegged to the US dollar are seeing their exports priced out of foreign markets as the dollar rises while other currencies plummet. The temptation is to unpeg ones currency from the USD in order to avoid this dilemma. But there is a price to pay for unpegging for economies like Hong Kong.

Hong Kong Dollar

Hong Kong is an Asian financial center which position might be hurt by unpegging from the USD. The Hong Kong Standard reports the details of the HK dollar hitting a four year low against the USD.

The level reached the midpoint of a 7.75-7.85 trading band under the currency peg with the greenback. It was “a matter of time that the outflow of funds from the HK dollar will lead to the triggering of the weak side,” said HKMA chief executive Norman Chan Tak-lam.

Chan said there are no plans to drop the peg.

For his part, Secretary for Financial Services and the Treasury Ceajer Chan Ka-keung said a faster pace of capital outflow might mean Hong Kong has to raise the interest rate sooner than some had forecast, although he believed a rise would be gradual.

The course for Hong Kong will be to adjust interest rates and make other internal modifications in order to cope, and not unpeg from the USD. That does not say that Hong Kong, Saudi Arabia, China and others will not let the peg range gradually slide to weaker levels! As always when trading currencies do your own homework first.