On the anniversary of the Chinese devaluation, the pressure now is on Hong Kon

The effects of the trade conflict between China and the USA are already being noticed on the economy of Hong Kong, often considered the freest economy of the world. The growth in Hong Kong's GDP declined in the second quarter, reflecting a combination of higher interest rates, trade conflict between the two most important economic partners to Hong Kong (China and the U.S.), as well as a decline in the growth rate of the Chinese economy. The hit on the economy is seen most clearly in the decline of containership thoroughput in the port of Hong Kong in the first half of 2018 compared with the same period last year. This year the port of Hong Kong was also surpassed by South Korea's Busan in terms of containers passing through it.

The combination of a slowdown in international trade flows, especially in the region of the Pacific, the geopolitical threats in the Pacific, and slowing growth in China express themselves as a strong pressure on HKD. It is not surprising then that USD/HKD is trading in the 7.841-7.85 range in the past three months. 7.85 is the upper bound of the currency peg of the HKD against the USD, as set by the Hong Kong Monetary Authority.

The risk of devaluation, assure experts and analysts, is minimal. What is interesting, however, is that the value of the HKD against the EUR also declines between April and August of this year (the period of strength of the USD): on 1.04.2018 1 EUR buys 8.27 HKD; today (10.08.2018) buys 9.23 HKD. This represents a 11,6% decline in the value of HKD against the EUR in 4 months. This is, of course, strange. As William Peshek of the Nikkei Asian Review explains, the HKD should be appreciating against the USD, because the currency peg of the HKD against the USD means that HKMA must mirror the actions and rate hikes of the Fed, which from the beginning of the year has been to raise rates.

The low value of the HKD against the USD can be explained by economic factors: a strong USD, combined with a weak Chinese economy and a weak yuan. We believe, however, that the high values of EUR/HKD hint at a weakness in the Hong Kong economy: this means that the low values of HKD against USD are the result of both strong dollar-weak yuan, and a weakness in Hong Kong's internal economy; this weakness, however, cannot be expressed on the chart of USD/HKD as price action due to the currency peg (between 7.75 and 7.85 against USD); proof of this is the devaluation of HKD in its other crosses (such as EUR/HKD).

Of course, expressing this position (long USD/HKD) has a minimal chance of gain: we believe the Hong Kong Monetary Authority has sufficient resources to maintain the peg within the 7.75-7.85 range, despite the fact that the cross has been trading virtually glued to its upper bound of 7.85 over the last few months. At the same time, the risk of further declines in China's growth rate, the pressure of a strong dollar and higher interest rates could pop the bubble in Hong Kong real estate; this would place serious economic strains on the key financial sector of the Hong Kong economy. In this situation, the Hong Kong Monetary Authority would likely have to reestablish its monetary policy: in other words, it would have to reconsider the peg of HKD against USD.