July 2, 2014 / 6:26 AM / 3 years ago

UPDATE 1-HKMA intervenes as deals, China optimism spur Hong Kong dollar gains

* HKMA intervention for first time in nearly 2 years

* Second busiest month for IPO markets this year

* Strong FX turnover on Hong Kong dollar

By Saikat Chatterjee

HONG KONG, July 2 (Reuters) - Hong Kong intervened to defend its currency peg for the first time in nearly two years as investor expectations for a rebound in Chinese equities boosted the local dollar.

More capital market activity from new listings and mergers and acquisitions also triggered unusual strength in the Hong Kong dollar, which tested the strong end of its trading band, prompting the monetary authority to step in from Tuesday.

The Hong Kong Monetary Authority (HKMA) bought a total of $2.1 billion in the past two days to restrain gains in the local currency, which is pegged to the U.S. dollar. That was the first time it did so since the fourth quarter of 2012, according to Thomson Reuters data.

Strength in the currency was not seen to be triggered by speculation over a revaluation of the peg, but rather signalled cautious optimism over the outlook for Chinese equities and the completion of recent capital market deals, traders said.

“If markets were expecting a peg move, we would have seen wholesale buying of the local dollar across the board on cash and forwards and given the current situation that is unlikely the case,” said the head of currency trading at a big Chinese bank in Hong Kong, referring to the big political protests on Tuesday.

The Hong Kong dollar is pegged at 7.8 to the U.S. dollar, but can trade between 7.75 and 7.85. Under the currency peg, the HKMA is obliged to intervene when the Hong Kong dollar hits 7.75 or 7.85 to keep the band intact.

The HKMA, the territory’s de-facto central bank, said the recent strength of the Hong Kong dollar reflected “increased corporate demand due to commercial activities, including merger and acquisition activities and dividend distribution.”

Turnover is brisk. Daily trading volumes in the Hong Kong dollar are a few hundred times the average volume over the last one month, Thomson Reuters data show, and at odds with other currencies where volumes have are more subdued.

STRENGTH SEEN SHORT-LIVED

Traders say the Hong Kong dollar’s rise is in lockstep with its decline in the forwards market indicating the local dollar’s strength is of a short-term nature and arising out of the short-term financing needs from banks and companies.

As the Hong Kong dollar hit the strong end of the currency trading band, the forwards market was pricing in near-term weakness in the local currency with 1-month, 6-month, and 12-month forwards declining in value.

FX options where many hedge funds typically bet on the direction of the currency were also lacklustre, a sign that local dollar strength was short-term in nature.

One-month USD/HKD 25-delta risk reversals, which indicate the extent of the bets on the local dollar, has been steady for a while implied volatility subdued

That trend is line with other Asian currencies such as the Korean won and Taiwan dollar where authorities have intervened sporadically because of a soft dollar.

Meanwhile, investors are returning to the equities market and underpinning the Hong Kong dollar. The local stock index has turned conclusively positive for the first time this year.

Primary market activity has also picked up. June was the second-highest month for IPOs in Hong Kong this year at $3.2 billion, according to Thomson Reuters data.

Oversea-Chinese Banking Corp Ltd (OCBC) said all the pre-conditions to an agreement to buy Hong Kong’s Wing Hang Bank Ltd had been satisfied, as various regulators had given their blessing to the $4.95 billion deal.

Additional reporting by Michelle Chen and Denny Thomas; Editing by Jacqueline Wong

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