The year 2021 started along with the correction in the US Dollar. While the fundamentals such as Biden’s $1.9 trillion stimulus and the Fed’s dovish outlook for the near future suggest anything but a weakness for the Dollar, the big technical picture shows the possibility of the dollar rally, at least in the short-term. Let’s look at the monthly chart of DXY below.
The current monthly candle has its low at around the long-term support of 88.5. The support has been tested three times since the 2008 financial crisis.
If the bullish reversal occurs, the most probable target will be around 92.5.
What are the implications of the possible bullish momentum in safe-havens? Most of the stock indices are already correcting, so you may look into the relatively strong ones, like Nikkei 225 or China A50.
Forex traders should observe JPY pairs. JPY has been outperforming USD and is likely to gain further momentum as the long-term USDJPY pattern plays out.
Next, we will look at alternative ways to take advantage of the possible DXY appreciation.
Get your trade “protected” by the HK bank with USD/HKD
In 1983, due to public concerns about the local currency depreciation, the Hong Kong Dollar was pegged to the USD at a rate of 7.8 per US Dollar. Later on, in 2005, the Hong Kong government allowed trading HKD in the narrow range between 7.75 and 7.85 per US Dollar.
Below is a chart of USD/HKD. You can see that the pair hasn’t violated the artificial range boundaries since 2005.
Note that the pair never stayed within 7.75-7.76 for more than 13 months (with the monthly open and close being within the 7.75-7.76 range), without the proceeding spikes. The pair held for 6.18 months on average before spikes. It’s the ninth month of being within the 7.75-7.76 range, and the next spike is likely soon.
The basic idea is to buy USD/HKD below 7.76 and hold until 7.80, or the middle of the range. The theoretical protective stop should be near 7.7450 to allow market noise around artificial support.
You can get a substantial 1:5 risk-to-reward potential of the trade if you manage to buy closer to 7.75 and hold until 7.8.
Why do we refer to this trade as “risk-free”? If you buy above 7.75, in theory, your position will be “protected” by Hong Kong Monetary Authority (HKMA), as HKMA is the “buyer” at 7.75, which has very deep pockets to sustain the peg. HKMA has $440 billion in reserve, six times outnumbering the currency in circulation, and China’s central bank’s support.
Hong Kong’s central bank managed to sustain the peg, withstanding numerous crises. As the current pandemic progresses, HKMA continues to hold the peg.
What are the risks?
The risks are political. The escalation of US-China tensions could lead to potential limitations of access to the US dollar set by the US forcing Hong Kong to end the peg.
What is the worst-case scenario if you’re long in USD/HKD, and HKMA lifts the peg? To imagine the possible scope of the event, let’s look at the case of EUR/CHF. In 2015 SNA canceled the EUR/CHF 1.2 peg. CHF shot up over 20% within a day!
If you happen to be long during this kind of crash, there is absolutely no guarantee that you’d get anything even close to your predefined stop-loss price due to liquidity problems. In fact, you cannot count on your pending orders.
Therefore, you need to have a way to protect yourself from this low-probability but possible event by limiting your risk.
Conclusion
The strength in the USD is likely, as DXY approached the long-term support area. You can use it as the opportunity to look for corrections that are morphing into trend-continuation setups in the strongest indices and to buy relatively strong safe havens such as JPY. USD/HKD provides a unique, high-probability trading setup based on artificial support. Make sure you know how to limit your risk in the event of unpeg, resulting in extreme fluctuations.
