Dislocations in FX Swap and Money Markets in Hong Kong and Policy Actions during the Financial Crisis of 2008

Abstract

When US dollar interbank markets malfunctioned during the global financial crisis of 2008, many non-US financial institutions relied heavily on FX swap markets for US dollar funds. This one-sided market induced a risk premium of the FX swap-implied US dollar rate across a range of funding currencies, i.e. a deviation from the covered interest parity (CIP) condition. The turbulence in the global interbank markets therefore spilled over to the FX swap markets, including that in Hong Kong. This paper analyses the effectiveness of the policy actions taken by the Hong Kong Monetary Authority and the government in responding to the dislocations and stress in the local interbank and FX swap markets. Our results show that the policy actions effectively ameliorated the FX swap market dislocations after the failure of Lehman Brothers, i.e. reducing the CIP deviations.