Hong Kong's Dollar Peg Holds Steadfast: Why Asia's Financial Stability Rests on LERS Resilience

The Hong Kong Dollar (HKD)'s peg to the U.S. dollar—enforced through the 45-year-old Linked Exchange Rate System (LERS)—has withstood its latest test in 2025, despite volatile global capital flows and macroeconomic headwinds. Recent foreign exchange interventions by the Hong Kong Monetary Authority (HKMA) underscore the system's adaptability, offering a bulwark of stability for Asian markets. Here's why investors should take note, and how to position for the opportunities ahead.

The Interventions: A Stress Test, Not a Crisis

In early May 翻25, the HKD surged to the strong end of its trading band (7.75 HKD/USD), driven by capital inflows from equity markets, dividend pre-funding, and regional currency appreciation. The HKMA responded decisively, selling HK$129.4 billion to buy $16.7 billion—a move that expanded the banking system's Aggregate Balance to HK$174 billion, nearly quadrupling in days. This injection of liquidity cooled interbank rates: the one-month Hong Kong Interbank Offered Rate (Hibor) dropped from 3.65% to 0.96%, while the overnight rate fell to 0.03%.

The intervention wasn't panic—it was the LERS's textbook response. When demand for HKD exceeds supply (e.g., via equity inflows), the system's automatic mechanisms trigger the HKMA to sell HKD and buy USD, preventing the currency from breaking its peg. The May actions were no exception, and they highlight the system's robustness.

Why LERS Works: A Self-Correcting Mechanism

The LERS is designed to balance supply and demand through interest rate differentials. When the HKD strengthens (as in May), the HKMA's liquidity injections lower Hibor, reducing the incentive to hold HKD. This creates a carry-trade dynamic: investors borrow in low-yielding HKD to invest in higher-yielding USD assets, thereby weakening the HKD back toward the lower end of the band (7.85).

This self-correcting loop ensures stability. For instance, after May's interventions, the HKD softened to 7.82 by mid-2025, nearing the weak side—a natural outcome of the system's mechanics. The HKMA's reserves ($420 billion) act as a buffer, while transparency measures (e.g., monthly reserve disclosures) build confidence in its ability to act.

Implications for Asian Markets

The HKD's stability is critical for Asia's financial architecture. Hong Kong remains the region's gateway to global capital, and its peg anchors confidence in cross-border flows. A collapse in the HKD would send shockwaves through Asian currencies, equity markets, and debt instruments. By contrast, its resilience signals to investors that Asia's financial systems can weather turbulence.

Three key ripple effects:
1. Capital Flows: A stable HKD reduces the risk of capital flight from Asian markets, encouraging inflows into equities and bonds.
2. Currency Stability: The LERS's success emboldens other Asian economies (e.g., Singapore, Malaysia) to maintain managed exchange rates amid Fed tightening.
3. Beijing's Backing: Hong Kong's role as China's financial hub ensures Beijing's implicit support for the peg, reinforcing regional stability.

Investment Strategy: Bet on LERS's Durability

Investors can capitalize on the HKD's stability through two channels:

1. HKD-Denominated Bonds: The recent drop in Hibor to near-zero levels (before rebounding) has made short-term HKD debt attractive. Look for dollar-cost averaging into short-term government bonds, which benefit from the peg's predictability. The yield gap between HKD bonds and U.S. Treasuries (narrowed by interventions) offers carry-trade potential.

2. Hong Kong Equities (HKEX): The Hang Seng Index's 10% YTD rise in 2025 reflects confidence in Hong Kong's financial system. Focus on financials (e.g., HSBC, Standard Chartered) and tech firms (e.g., Tencent-backed stocks), which benefit from liquidity injections and equity inflows. The Southbound Stock Connect's record flows (HK$20 billion/month) suggest sustained demand.

Risks and Considerations

• Fed Policy: If the Fed hikes rates further, the HKD could weaken toward 7.85, tightening liquidity and raising borrowing costs. Monitor the Hibor-Fed Funds rate spread closely.
• Geopolitical Tensions: U.S.-China trade disputes or sanctions could disrupt capital flows. However, Beijing's commitment to Hong Kong's stability mitigates this risk.

Conclusion

The HKD's peg has survived its 2025 stress test, proving the LERS's staying power. For investors, this is a signal to embrace Asian markets with confidence. Positioning in HKD bonds and Hong Kong equities offers a dual play: exposure to the system's self-correcting mechanisms and the region's growth narrative. As long as the HKMA's interventions and Beijing's support hold firm, Asia's financial heart will keep beating.

Final recommendation: Allocate 5-10% of a global portfolio to HKD bonds and Hong Kong equities, hedged against USD volatility.