There are two currency pegs that serve as bedrocks, the Hong Kong dollar and Saudi Arabia’s riyal. They were not tackled in the series of emerging market crisis that began in the mid-1990s. They did not succumb during the Great Financial crisis. Yet the market is betting that they fall. You can’t see the pressure looking at the spot market. They are pegged, after all. Rather you can see speculation of a possible regime change can be expressed in the forward market.
The chart below shows the 12-month forward points for the Saudi riyal. The upward spikes reflect periods of more intense speculation that Saudi Arabia may weaken its currency. The latest one is driven by new declines in oil prices and a draw down in the country’s FX reserves. The pressure in the Saudi 12-month forward encountered mild upside pressure in July, but it has intensified over the last couple of weeks. Recall that Asia’s largest oil exporter, Kazakhstan, had tried to maintain a peg currency regime until deciding to let tenge float last week. It warned that other oil producers face the same choice.
The pressure on the Hong Kong dollar forwards is new. The forward points held fairly steady as the Chinese stocks sold off hard in July. They turned more volatile since China devalued the yuan, but soared today after the Hang Seng fell 5.2% and the Shanghai Composite fell 8.5%. The 12-month forward points for the Hong Kong dollar rose to the highest since Lehman failed.
The pressure on the Hong Kong peg can also be seen in the options markets. For example, the 1-year implied volatility, for example, spiked to levels not seen since late 2004.
We suspect that monetary authorities in Riyadh, Hong Kong, and Beijing are loath to be pushed into a change policy by market participants. In 1997, Hong Kong launched a strong and successful defence of its peg. Saudi Arabia has frustrated leveraged players who from time-to-time have thought the riyal was vulnerable. The key judgment call is whether there is the political will to continue doing so. We think there is.
For market participants, however, the forward points may be used as a non-equity market gauge of the fear factor. It is telling us the same thing that the S&P 500 is when it is four standard deviations from its 20-day moving average. The market move is excessive, but technical indicators have not signalled that the excess is over.