1. KBank Capital Market Perspectives Market Updates
Macro / FX / Rates
Opportunity for to hedge borrowing costs
24 June 2011
Overview:
Since May, the interest rate swap (IRS) rates had declined steadily, causing the
spread between bond yields and the IRS rates to narrow significantly. While many Nalin Chutchotitham - Kasikornbank
nalin.c@kasikornbank.com
forces are at play, the most prominent one comes from the falling of swap points
or forward points. In our view, this is a good opportunity to fix borrowing costs.
Given that the policy rate remained on the up-trend and the inflation rate is unlikely
to fall from 4.0% in the second half of this year, we expect interest rates to
gradually rise going forward. In fact, bond yields had picked up significantly this
week, by 12-17bp from levels on June 17th. Investors are deemed to be aware of a
possible policy rate hike on July 13th and selling bonds ahead of Q4/FY2011 bond
supply announcement next week. IRS yields could follow suit but they had
remained rather stable, offering opportunities to hedge costs.
Factors at play:
1. As Greece’s debt crisis heightens, the financial markets began to raise
awareness about possible shortage of USD liquidity. This causes commercial
banks to avoid swapping out dollars (sell-buy USD/THB) i.e. hoard dollars on
hand. At the same time, they engage in short-term swapping-in of the dollars
(buy-sell USD/THB) to ensure adequate supply of U.S. dollar on hand. In sum,
these trades reduce the USD/THB swap point or the THB forward premium.
2. Recent weakness in the Thai baht, especially against the U.S. dollar, reduces the
need for aggressive FX intervention by the Bank of Thailand (BoT). Hence, the
demand for sell-buy USD/THB from the BoT has also subsided in recent trade
and offer less support for the swap points to climb higher.
3. Local mutual funds had been increasing investment in the offshore renminbi
deposits (CNH) and other emerging markets e.g. Middle-Eastern markets. Such
investments (called Dimsum funds for those involving CNH) allow for yield
enhancement over the returns on short-term local debt securities. Commercial
banks that engage in asset swaps with the funds would find their U.S. dollar on
hands reducing, and may have to buy-sell USD/THB in the short-run whenever
there is a concern for the availability of USD in the market. Once again, the latter
trade helps to drive down swap rates.
* We provide further details and explanations on the next pages
Bond-swap spreads Interest rate swap rates
bps %
120 5.0
100 4.5
80 4.0
60 3.5
40
3.0
20
2.5
0
2.0
-20
-40 1.5
-60 1.0
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11
2Y bond-swap spread 5Y bond-swap spread Policy rate 2Y 5Y 10Y
Source: Bloomberg, KBank Source: Bloomberg, KBank
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2. Comparing costs of borrowing: government, banks and Comparing costs of borrowing: government, banks and
corporate – 2Y corporate – 5Y
% %
4.5 5.0
4.0 4.5
3.5 4.0
3.0 3.5
2.5 3.0
2.0 2.5
1.5 2.0
1.0 1.5
Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11
Govt Bond 2Y IRS 2Y AA rating corporate bond 2Y Bond 5Y IRS 5Y AA rating corporate bond 5Y
Source: Bloomberg, KBank (ThaiBMA reported that more than 80% of the outstanding Source: Bloomberg, KBank, (ThaiBMA reported that more than 80% of the outstanding
corporate bonds in Thailand are rated in the “A” category) corporate bonds in Thailand are rated in the “A” category)
Comparing the THB/THB interest rate swap curve Headline and core inflation rates
%
4.5 10%
4.0 8%
6%
3.5
4%
3.0 2%
0%
2.5
24-Jun-11 -2%
2.0 1-month ago -4%
3-month ago tenor -6%
1.5
05 06 07 08 09 10 11
1W 1M 2M 3M 6M 9M 1Y 2Y 3Y 4Y 5Y 7Y 10Y 12Y 15Y CPI yoy Core CPI yoy
Source: Bloomberg, KBank Source: Bloomberg, KBank
Background/explanations:
1. In expectation of higher inflationary pressure and policy rate hikes, local commercial
banks had been betting on higher implied THB rates. They reflect this view by bidding up
the forward points or swap points, leading to higher THBFIX rates, which in turn, pushed
up IRS rates. There is no problem with such trades in normal market conditions. (please
see formula for THB fixing rates below)
However, whenever there are major events with negative impact on the willingness of
banks to lend or provide USD liquidity, such as the collapse of Lehman Brothers’ in 2008
and the Dubai World’s insolvency in 2010, implied THB rates could reverse trend rapidly.
Commercial banks with substantial long positions in the USD/THB FX swap had to offset
such positions via shorter-tenor USD/THB FX swaps in the opposite direction. At present,
the Greece debt crisis is playing the role of such a negative trigger and swap points had
fallen substantially, reflecting reduced forward premium in the THB.
Thomson Reuters calculation methodology for THB interest rate fixing
THBFIX = ( { ( [1+(Fwd/Spot)] x [1+(Sibor x Days/360)] ) -1} x 365/Days)x100
Note – The formula above is derived from an economic concept called the interest rate parity condition. It states that, under no-
arbitrage condition, (1 + i$) = (F/S)(1+ ic) where i$ and ic are the interest rates of two countries and F and S are the forward and spot
exchange rates between them. Such a condition says that returns for depositing money in either currency would not be different,
given the stated foreign exchange rates and interest rates.
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3. Further explanation - Commercial banks had been buying USD/THB FX swaps
(Sell-Buy) due to expectation of continued policy rate hike and relatively stable U.S.
interest rates. Such trades induced a higher forward premium in the THB, and
swap points continued to climb. Banks usually fund such trades, usually done for
long-tenor FX swaps such as 3m - 12m, with shorter-tenor swaps on the reverse
side (Buy-Sell). When the swap point curve is steep, such trades are profitable for
the banks going long (implied yield on THB increases with higher forward
premium).
Now, the counter-party for the Buy-Sell had predominantly been the Bank of
Thailand and when the central bank reduces their FX swap volume, the swap
points usually collapsed. This occurs from time to time when the central bank sees
less need of FX intervention and commercial banks’ profits from such trades fall as
a result.
Fixing rates curve THBFIX rates 1m and 6m
% THB fixing rates and IRS %
3.5
3.50
3.0
3.30 2.5
2.0
3.10
1.5
2.90 1.0
0.5
2.70
0.0
2.50 -0.5
1Wk 1M 2M 3M 6M 9M 1Y IRS 1Y IRS 2Y Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11
current 5-day ago 1-m ago THBFIX1M THBFIX6M
Source: Bloomberg, KBank Source: Bloomberg, KBank
2. The Bank of Thailand seemed to have reduced their Sell-Buy USD/THB transactions
during the past few weeks. This is mainly because of the depreciation of Thai baht
against many currencies during the same period or relatively high volume of Sell-Buy
USD/THB in earlier periods, especially in March and April. Due to the need for FX
intervention, the BoT is the primary player in sell-buy USD/THB trades, and their absence
could cause swap points to suddenly slump.
BoT’s forward positions and foreign reserves USD/THB rebounded in recent weeks
USD bn Cumulative change since Jan 2010 USD bn
31.20
10 70
8 60 31.00
6 50 30.80
4 40 30.60
2 30 30.40
0 20
30.20
-2 10
30.00
-4 0
-6 -10 29.80
Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 1-Jan 1-Feb 1-Mar 1-Apr 1-May 1-Jun
BoT's forward positive (left) Foreign reserves (right) USD/THB
Source: Bloomberg, KBank Source: Bloomberg, KBank
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4. Further explanation – The BoT buys the U.S. dollar and sells Thai baht in the
market to weaken the baht’s strength in periods when rapid appreciation of the
baht (trade in the opposite direction has also been done). This is called FX
intervention and it could prevent smooth out some volatility in the market and allow
time for exporters and importers to adjust.
There are two primary channels in which the BoT manages Thai baht liquidity in
the market after FX intervention. The first is to issue BoT bonds and bills while the
second is to Sell-Buy USD/THB. The effect of the second channel allows the BoT
to both release excess USD in their holding (and return USD liquidity to the market)
and reduces Thai baht in the market.
3. Recalling the asset swap trades involving the Korean bond funds, investment in
CNH deposits and other emerging market’s deposits are all based on similar
principle. Local asset management companies (AMCs) seek out opportunities for yield
enhancement over the relatively low yields of local government treasury bills and central
bank yields by swapping out THB funds for foreign assets. In certain periods, market
conditions are such that asset swap trades could provide very attractive investment
returns. Hence, AMCs would engage in more of such investments and the resulting
impact on the market is that commercial banks’ position would be biased towards one-
sided trade, which is sell-buy USD/THB.
To clarify further, the deposit rates in CNH are not particularly high. In fact, they are low;
1-year deposit rate at 0.8-1.50%, depending on the demand of CNH deposits and loans.
Nevertheless, the USD/CNH cross-currency swap curve (CCS) in recent months shows a
deep forward discount in the CNH, despite that fact that interest rates in China are higher
than that of the U.S. (which violates that interest rate parity condition). The reason for this
is that the market expects continued appreciation of the renminbi i.e. spot USD/CNY and
spot USD/CNH are likely to decline much lower from current levels.
Further explanation – Commercial banks’ asset swaps with AMCs is usually done
for 6-month to 1-year tenors. Banks provide USD to the AMCs by having to buy-sell
USD/THB in the interbank market but using short-tenor trades, which are usually
more liquid. As a result of maturity mismatch, commercial banks have to carefully
manage their demand and supply of U.S. dollar carefully. In situations when banks
are concerned with USD liquidity in the market, they would seek to maintain
sufficient USD on hand, accelerating the buy-sell USD/THB trades and pressured
the swap points lower. In serious shortage of the USD, the implied interest rates on
THB (i.e. THBFIX) could be much lower than the local money market rates.
Offshore yuan deposit rate vs. 1-year swap implied yield Approximate return on CNH/THB asset swap
% %
2.5 9 1Y Thai bond yield
2 8 Approx. return on CNH/THB asset swap
1.5 7 Approx. return on KRW/THB asset swap
1 6
0.5 5
0
4
-0.5 3
-1
2
-1.5
1
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11
0
1Y CNH deposit rate 1Y USD/CNH CCS implied yield Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11
Source: Bloomberg, KBank Source: Bloomberg, KBank
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5. In any case, we do not expect that the rise in CNH deposit investment to cause much of a
problem going forward. The large amounts of Korean bond funds maturing in June and
during the rest of the year would help to provide USD liquidity to the market. At the same
time, the rollover of investment funds are likely to be much smaller compared to the size
of the funds flowing back home. Retail investors are also reallocating their savings into
local time deposit accounts and local money market funds as deposit rates begun to pick
up. Moreover, the levels of USD libor and sibor show that there is no big concern for USD
liquidity. The lower swap points in the FX swap is trading lower only because of local
banks’ position and is only suggesting of an increased in awareness of the possible
liquidity problem due to Greece’s debt crisis. Hence, we do not think that the condition of
low IRS rates would remain for a long period of time.
THBFIX6m – overnight repo rate Fig 8. USD Libor rates
bps %
Lehman brothers' fall 2.0
150 Dubai World 1.8
debt crisis local USD
100 1.6
liquidity
1.4
50 shortage
1.2
0 1.0
0.8
-50 0.6
-100 0.4
0.2
-150 0.0
Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11
Difference between 6m THBFIX and policy rate Libor 3m Libor 6m Fed funds rate
Source: Bloomberg, KBank Source: Bloomberg, KBank
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6. Table 1. Monthly Key Economic Indicators Oct 10 Nov 10 Dec 10 Jan-11 Feb-11 Mar 11 Apr 11 May 11
Manufacturing index (ISIC) 188.0 189.1 189.9 192.9 188.7 187.0 180.8
% YoY 6.0 5.7 -3.4 4.1 -3.0 -6.7 -7.8
Industrial capacity utilization rate (%) (ISIC) 63.9 63.6 62.4 62.3 59.5 66.1 54.6
Retail sales (% YoY) 5.3 8.1 7.8 9.3 8.6 3.9 n.a.
Total vehicle sales (units) 72,012 78,874 93,122 68,398 77,213 93,008 67,283
Motorcycle sales (units) 143,791 152,767 167,707 165,152 188,248 191,437 174,244
Unemployed labor force ('000 persons) 355 389 268 374 268 276 n.a.
Unemployment rate (%) 0.9 1.0 0.7 1.0 0.7 0.7 n.a.
Consumer prices (% YoY) 2.8 2.8 3.0 3.0 2.9 3.1 4.0 4.2
core 1.1 1.1 1.4 1.3 1.5 1.6 2.1 2.5
Producer prices (% YoY) 10.0 7.1 4.7 6.0 7.4 5.9 6.6 6.2
External Accounts (USD mn, unless specified otherwise)
Exports 17,046.0 17,584.0 17,220.0 16,523.0 18,406.0 21,072.0 17,243.0
% YoY 16.6 28.7 18.6 21.4 29.1 31.0 24.7
Imports 14,773.0 17,094.0 15,911.0 17,111.0 16,375.0 19,180.0 17,720.0
% YoY 14.4 35.0 8.8 31.2 18.6 27.2 26.3
Trade balance 2,273.0 490.0 1,309.0 -588.0 2,031.0 1,892.0 -477.0
Tourist arrivals ('000) 1,360 1,500 1,840 1,810 1,822 1,765 1,498
% YoY 6.3 10.3 9.5 12.8 12.8 22.7 35.2
Current account balance 2,740.0 1,019.0 1,750.0 1,090.0 3,823.0 1,881.0 -165.0
Balance of payments 5,822 820 2,263 1,689 4,271 1,365 3,570
FX reserves (USD bn) 171.1 168.0 172.1 174.0 179.5 181.6 189.9
Forward position (USD bn) 12.6 15.1 19.6 19.3 17.9 21.0 21.4
Monetary conditions (THB bn, unless specified otherwise)
M1 1,202.3 1,235.4 1,302.4 1,326.2 1,346.4 1,345.6 1,347.6
% YoY 11.4 10.8 10.9 15.5 13.4 13.8 14.0
M2 11,323.3 11,497.6 11,776.4 11,817.2 12,152.9 12,280.3 12,469.3
% YoY 11.2 11.1 10.9 11.5 13.7 13.1 15.1
Bank deposits 10,206.0 10,387.9 10,584.9 10,606.3 10,834.2 10,891.3 10,964.4
% YoY 8.5 8.1 8.7 8.8 10.3 9.0 9.9
Bank loans 9,580.3 9,751.1 9,947.0 10,064.5 10,209.7 10,308.2 10,375.0
% YoY 12.1 12.3 12.6 14.5 15.1 14.9 15.3
Interest rates (% month end)
BOT 1 day repo (target) 1.75 1.75 2.00 2.25 2.25 2.50 2.75 2.75
Average large banks' minimum lending rate 6.00 6.00 6.12 6.37 6.37 6.62 6.75 6.75
Average large banks' 1 year deposit rate 1.11 1.11 1.32 1.51 1.51 1.67 1.86 1.86
Govt bond yield 1yr 1.98 2.11 2.38 2.54 2.68 2.83 3.00 3.15
Govt bond yield 5yr 2.83 2.98 3.26 3.40 3.48 3.41 3.38 3.50
Govt bond yield 10yr 3.18 3.59 3.77 3.85 3.89 3.75 3.70 3.79
Key FX (month end)
DXY US dollar index 77.27 81.20 79.03 77.74 76.89 75.86 72.93 74.64
USD/THB 29.94 30.21 30.06 30.93 30.60 30.28 29.88 30.32
JPY/THB 37.18 36.11 37.01 37.60 37.47 36.42 36.80 37.17
EUR/THB 41.76 39.22 40.23 42.35 42.25 42.86 44.24 43.64
Source: Bloomberg
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7. Disclaimer
For private circulation only. The foregoing is for informational purposes only and not to be considered as an offer to buy or
sell, or a solicitation of an offer to buy or sell any security. Although the information herein was obtained from sources we
believe to be reliable, we do not guarantee its accuracy nor do we assume responsibility for any error or mistake contained
herein. Further information on the securities referred to herein may be obtained upon request.
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