Hong Kong one-hundred dollar banknotes are arranged for a photograph in Hong Kong, Jan 20, 2016. (JUSTIN CHIN / BLOOMBERG)

The Hong Kong dollar is suddenly looking vulnerable, after weeks of trading at the strong end of its band against the greenback.

Late on Friday, the currency weakened rapidly in its biggest drop since mid-June. The decline was unexpected, given persistent inflows into the special administrative region (SAR), but may have been triggered by concern about possible financial sanctions and a narrowing of the yield gap between the Hong Kong and US dollars.

There is so far little evidence that traders are betting on sustained weakness. The Hong Kong dollar's three-month risk reversal, a gauge of bearishness in the options market, is close to the lowest level since August

Traders are watching the Hong Kong dollar closely for any signs of outflows from the SAR.

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“The depreciation might be an early sign of concerns over the US’s financial sanctions as supportive factors such as large listings and dividend payments may start to cool down later in July,” said Ken Cheung, chief Asian currency strategist at Mizuho Bank Ltd. “The narrower rate spread with the greenback is also hurting the Hong Kong dollar, which may stay away from the strong end and weaken to 7.7550 in the near term.”

The Hong Kong dollar was 0.03 percent stronger as of 2:37 pm local time on Monday, virtually wiping out the decline at the end of last week.

There is so far little evidence that traders are betting on sustained weakness. The Hong Kong dollar’s three-month risk reversal, a gauge of bearishness in the options market, is close to the lowest level since August despite a small uptick on Friday. The currency’s forward points of the same tenor are near a four-month low, reflecting limited concerns on depreciation or liquidity tightness.

The gap between the Hong Kong dollar’s one-month Hibor and the borrowing costs on the greenback was last at 22 basis points, close to the 20 basis point level which OCBC Wing Hang Bank Ltd. has said would make the long carry trade unattractive.

The Hong Kong Monetary Authority sold HK$48.7 billion (US$6.3 billion) last week alone to keep the currency from strengthening beyond its trading band. That was despite news some Trump aides are considering ways to undermine the peg mechanism, according to people familiar with the matter.

Friday’s loss also came after the Hang Seng Index fell 1.8 percent, paring its gain for the week to 1.4 percent.

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