"Invest in inflation. It's the only thing going up."
-Will Rogers

Bill Ackman Bets Hong Kong Will Let City’s Currency Appreciate

By Katherine Burton and Fion Li
September 15, 2011 (Bloomberg)

(Adds Hong Kong Monetary Authority’s response in fourth paragraph.)

Sept. 15 (Bloomberg) -- William Ackman, founder of hedge fund Pershing Square Capital Management LP, said he’s placed a wager that would profit if Hong Kong allows its currency to appreciate against the dollar.

Ackman is buying Hong Kong dollar call options, which give investors the right to buy the currency at a set price by a specific date, because they are inexpensive, he said. The easiest way for the authorities to allow the currency to appreciate would be to change the peg to HK$6 versus per U.S. dollar, a 30 percent gain, and then link to the yuan over three to six years, he said.

“It’s a small trade, but if it’s successful, it will be our most profitable,” said Ackman, speaking at an investor conference yesterday in New York organized by CNBC and Institutional Investor.

The Hong Kong dollar has been kept at about HK$7.80 versus the greenback since 1983, causing it to weaken 7 percent against the Chinese yuan in the past two years, fueling inflation and a surge in property prices. The Hong Kong Monetary Authority “has no plan or intention to change the system as it continues to serve Hong Kong well,” the de facto central bank said in an e- mail reply to questions from Bloomberg News today.

Given the small and externally oriented nature of the Hong Kong economy, maintaining exchange-rate stability remains appropriate for the city, the Hong Kong Monetary Authority said in an earlier reply on Sept. 6.

Implied Volatility

The implied volatility on two-year options for the exchange rate between U.S. and Hong Kong dollars has jumped to 3.6 percent from 1.7 percent at the start of the year, according to data compiled by Bloomberg. Implied volatility, which traders quote and use to set option prices, signals the expected pace of swings in an underlying currency.

Implied volatility on two-year options for the exchange rate between U.S. and the yuan rose to 7.37 percent from 5.25 percent at the beginning of the year, Bloomberg data show.

The fixed exchange rate means Hong Kong monetary policy is largely dictated by the U.S., where a 9.2 percent jobless rate and housing slump have led the Federal Reserve to favor near- zero interest rates and asset purchases to prop up the economy. Hong Kong’s 3.5 percent unemployment rate is near the lowest level since 2008, and real-estate values climbed in each of the last 10 quarters, jumping 75 percent in that time. Inflation was 7.9 percent last month, the fastest pace since 1995.

Interest Rates

Some economists and bankers agree that Hong Kong can’t sustain the current peg with the U.S. dollar. In January, Hong Kong lawmakers Chim Pui Chung and Lam Tai Fai urged a review of the peg. HSBC Holdings Plc chief executive Stuart Gulliver and his counterpart at the Bank of East Asia Ltd., David Li, said last month that any shift by Hong Kong could be to a link with a basket of currencies.

“The inflation print in Hong Kong remains quite high and the low-interest rate policy isn’t appropriate,” said David Dimmock, director of fixed income and currencies at Societe Generale SA in Hong Kong. “However, with slowdown in growth and more uncertainty in the global environment, it’s difficult to see the HKMA will take the risky move to change the policy until things settle down.”

Chinese officials told European Union business executives that the yuan will achieve “full convertibility” by 2015, EU Chamber of Commerce in China President Davide Cucino said on Sept. 7. Inability to exchange the currency freely prevents it from being used in reserves or in a linked exchange-rate system.

“Pegging the Hong Kong dollar to the yuan is only possible when the Chinese currency is convertible, which will likely be in at least 2015,” said Tommy Ong, senior vice-president of treasury and markets at DBS Bank (Hong Kong) Ltd. “Linking to an appreciating currency like the yuan could harm Hong Kong’s exports. It’s not something Hong Kong wants to see given the gloomy economic outlook.”

Ackman, 45, has been hinting at a new trade since an Aug. 17 investor letter, in which he wrote about “an attractive standalone investment and one that offers significant hedging benefits for our portfolio. For a modest amount of capital commitment, this investment offers the potential for extraordinary profits.”

--Editors: Christian Baumgaertel, Ven Ram

To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net; Fion Li in Hong Kong at fli59@bloomberg.net

To contact the editor responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net

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