The critical moment for HKD to TWD exchange rate is here. Is there still hope after the 4.05 rebound?

The exchange relationship between the Hong Kong dollar and the New Taiwan dollar influences investors in both Hong Kong and Taiwan. According to statistics, in 2023, Hong Kong visitors reached 770,000, becoming the largest source of inbound tourists to Taiwan. This reflects the active economic and trade exchanges between the two regions. The trend of the HKD to TWD exchange rate also directly impacts the costs and profits of these business activities.

Resilience of the HKD from the Linked Exchange Rate System

The story of the HKD begins in mid-20th century Hong Kong, evolving from a silver standard to a currency pegged to the US dollar. In October 1983, Hong Kong officially implemented the Linked Exchange Rate system, anchoring the HKD within a range of 7.75 to 7.85 against the USD. This mechanism has remained in place ever since.

The benefit of this pegged system is that when the HKD weakens, the Hong Kong Monetary Authority (HKMA) buys HKD and sells USD at the 7.85 level to provide support; when the HKD strengthens, it conducts the opposite operation at 7.75. Thanks to this rule, a solid defensive line has been formed between the HKD and USD.

Long-term Pattern of HKD to TWD

Since 2007, the HKD to TWD has generally operated around a central pivot of 4.0, reaching a high of 4.5 and a low of 3.5. This data signals an important message: although the exchange rate fluctuates, it has not deviated significantly from its established track.

After 2022, the HKD to TWD began a new rebound, gradually rising from the 3.5 bottom. However, the upward process has not been smooth. Resistance around 4.15 has frequently hindered the price. By February 2024, amid high US inflation data and political instability in Taiwan, the HKD to TWD rebounded to around 4.05.

Current Situation: Federal Reserve Decisions Are Key

The market developments since February 2024 tell two stories.

First, from the US perspective. CPI and PPI data both exceeded expectations, shattering hopes of a rate cut in March. The US dollar thus gained breathing room, and the HKD to TWD moved higher accordingly.

Second, from Taiwan’s perspective. After the Democratic Progressive Party (DPP) was elected, the Legislative Yuan did not hold a majority, creating a “divided government” scenario that raised concerns among foreign investors about cross-strait prospects, putting downward pressure on the TWD. Under these dual negative factors, the HKD to TWD rose from 3.905 to 4.05.

Two Possible Future Scenarios

Optimistic Scenario: Rate Cut Cycle Begins

The Fed is likely to cut interest rates, unless a black swan event related to inflation occurs. Starting a loosening cycle in 2024 is widely accepted. Historical experience shows that during rate cut periods, the HKD to TWD tends to face downward pressure. Data from the 2008 financial crisis and the 2019 trade war indicate declines of 9.88% and 13.17%, respectively, during two rate-cut cycles.

Applying a 10% decline estimate, from the high of 4.15, the HKD to TWD could fall to around 3.735.

Cautious Scenario: US Economy Outperforms Expectations

If the US economy continues to perform strongly, or geopolitical conflicts push oil prices higher and boost inflation, the Fed might delay or abandon rate cuts. In this case, the HKD to TWD could actually rise, with the first target at 4.15, the previous high and the top of the long-term downtrend channel.

Who Is Driving the HKD to TWD Price?

US interest rates are the main driver

The peg of the HKD to the USD determines that its exchange rate must follow Federal Reserve policies. Rate hikes promote HKD appreciation, while rate cuts exert depreciation pressure. Key economic data such as non-farm payrolls and retail sales influence Fed expectations, thereby affecting the HKD to TWD.

The impact of Taiwan’s economic conditions cannot be ignored

The health of Taiwan’s economy influences capital inflows and outflows. In late 2021, Taiwan’s annual growth rate reached a high of 6.1%, with strong exports and investments attracting foreign capital, which caused the TWD to appreciate and the HKD to TWD to fall toward 3.5.

However, since 2022, Taiwan’s economy has cooled significantly, with GDP growth slowing and even turning negative in early 2023. The TWD depreciated accordingly, and the HKD to TWD rebounded from 3.5 to 4.15. Cross-strait political developments also influence investor expectations; the political change in 2015 brought uncertainties that contributed to Taiwan’s economic slowdown.

Global risk sentiment shifts

When the global economic outlook dims, risk-averse capital flows into the US dollar, benefiting the HKD due to its peg to USD. Meanwhile, the TWD, representing Asian risk assets, is sold off, causing the HKD to TWD to rise.

Will the Linked Exchange Rate Break?

Discussions about the HKD disconnecting from the USD have never ceased. After the 1998 Asian financial crisis, currencies of Japan, Korea, and Southeast Asian countries depreciated, attracting capital inflows and leading to rapid economic recovery. Hong Kong, however, being pegged to the USD, lost this flexibility, resulting in underperformance of its stock and property markets for over a decade.

Recently, with the internationalization of the RMB and tense US-China relations, some voices advocate for the HKD to be linked to the RMB instead. But after multiple rounds of financial and political turbulence, the HKD’s linked exchange rate system remains resilient. Unless facing extreme crises like US sanctions or war, investors need not overly worry.

Practical Recommendations

For investors considering trading the HKD to TWD, prioritization should be layered: when judging the overall direction on an annual basis, the Fed’s monetary policy takes precedence, followed by Taiwan’s economic outlook. For intraday short-term trading, technical analysis and pattern recognition can be used to find opportunities.

As for arbitrage within the 7.85-7.75 linked exchange rate band, it is theoretically feasible. However, in practice, interest costs, time costs, and transaction fees will erode profits, and retail investors often find the actual gains minimal or even result in losses.