Hong Kong Dollar Bonds: A Strategic Bet in a Volatile Liquidity Landscape

In the summer of 2025, Hong Kong's financial markets have become a laboratory for testing the resilience of the Linked Exchange Rate System (LERS) and the interplay between liquidity management and fixed-income valuations. As borrowing costs for Hong Kong dollars (HKD) plummeted in May and began to rebound in July, the resulting volatility has created a unique opportunity for investors to identify undervalued bonds. The key lies in understanding how currency interventions, shifting HIBOR rates, and forward rate dynamics are reshaping the landscape for fixed-income instruments.

The Liquidity Shift and HIBOR Dynamics

The Hong Kong Interbank Offered Rate (HIBOR) has swung dramatically this year, driven by the HKMA's interventions to stabilize the HKD peg. After the May surge in liquidity—triggered by a strong-side Convertibility Undertaking (CU)—short-term HIBOR rates collapsed. The overnight rate plunged to 0.03% by late May, a historic low, before rebounding slightly to 0.09% by mid-July as the HKMA absorbed excess liquidity through weak-side CU interventions. Meanwhile, the one-month HIBOR dropped to 1.08%, narrowing but still trailing far behind U.S. dollar rates.

This divergence has created a conundrum for investors: while short-term HKD borrowing costs remain depressed, the risk of a rebound looms large. The HKMA has warned that further tightening of liquidity—via continued interventions to defend the HKD's lower bound of 7.85—could push HIBORs higher, narrowing the gap with U.S. rates.

HKMA Interventions and Bond Valuations

The HKMA's actions have directly influenced the Aggregate Balance, a critical gauge of banking system liquidity. By selling US$9.22 billion since late June and reducing the Aggregate Balance to HK$101.2 billion, the authority has tightened funding conditions, altering the calculus for bond investors.

For bonds priced in HKD, this environment presents a paradox. Short-term instruments may see yields pressured by lingering liquidity, but longer-dated bonds could benefit from the HKMA's unwavering commitment to the peg. The 30-year Hong Kong government infrastructure bonds, for instance, now offer a yield of 3.85%, a compelling spread over shorter-term rates and a potential hedge against future HIBOR increases.

Leveraging Forward Rate Dynamics

Investors must also factor in forward rate expectations. While short-term rates may oscillate with liquidity swings, longer-term HIBORs are tied to U.S. Federal Reserve policy and the HKMA's ability to sustain the peg. If the Fed eases rates later this year—as some analysts predict—the differential between HKD and USD rates could shrink, reducing the incentive for carry trades and stabilizing the HKD.

This creates a window to lock in higher yields on long-dated bonds, which are less sensitive to near-term volatility. For example, the 30-year HKD bond's 3.85% yield compares favorably to its 2.1% yield in 2023, offering a premium for investors willing to ride out short-term turbulence.

Risks and Considerations

The opportunity is not without risks. Carry trades remain a double-edged sword: while they have fueled demand for USD assets, abrupt reversals could amplify HKD volatility. The HKMA's Aggregate Balance—a proxy for liquidity—is now at HK$101.2 billion, a level that may prompt further interventions if capital outflows intensify.

Moreover, global macroeconomic factors, such as tech-sector volatility (as seen in the Hang Seng TECH Index's decline this year), and geopolitical risks could spill over into bond markets.

Investment Strategy: Prioritize Duration, Mind Liquidity Risks

The optimal strategy balances exposure to long-dated bonds while hedging against HIBOR volatility. Investors should:
1. Focus on long-term HKD bonds: Instruments like the 30-year government infrastructure bonds offer a yield cushion against rising rates.
2. Avoid short-term paper: One-month HIBOR-linked notes may face downward pressure as liquidity tightens further.
3. Monitor liquidity metrics: Track the Aggregate Balance and HKD/USD exchange rate to anticipate HKMA actions.
4. Consider hedging: Use forward contracts or USD-denominated bonds to mitigate currency risk if the HKD weakens toward its peg boundary.

Conclusion

Hong Kong's bond market is at an inflection point. The interplay of falling borrowing costs, HKMA interventions, and forward rate expectations has carved out an opportunity to profit from undervalued fixed-income instruments—but only for those willing to navigate liquidity risks and geopolitical headwinds. The 30-year HKD bonds, with their robust yield and alignment with the HKMA's policy framework, stand out as a strategic bet for investors seeking stability in an unstable environment.

In a market where every basis point counts, patience and a long-term horizon will be rewarded.