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K bank fx & rates strategies expect higher floating rates

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  • 1. Economics /.Mean S FX & Rates Strategies KBank Strategy Expect higher floating rates FX / Rates 17 February 2011 Thai interest rate swaps rose rapidly with 6-month floating rate breaching its highest level since April 2009 Nalin Chutchotitham nalin.c@kasikornbank.com Recent movements in the THB interest rate swap market showed that we are moving out of the low floating rates environment There is no hurry for hedgers to convert to the fixed rate side, but it is also worth exploring the market for paying fixed interest rates in tenors not more than 3 years The market is aggressively pricing in further rate hikes by BoT while a reduction in foreign security investment and BoT’s Disclaimer: This report sterilization are helping to lift short-dated swap rates must be read with the Historically, 6-month floating rates is higher than repo rate and Disclaimer on page 5 that forms part of it we expect that it would at least follow BoT’s rate hikes higher We continue to expect 25bp hikes during the next 3 MPC meetings while repo rate could reach 3.25% by Q3 KBank Capital Market Research can now beSurges in short-dated swaps accessed on Bloomberg: KBCM <GO>Recent movements in the THB interest rate swap market showed that we are moving outof the low floating rates environment that spanned over most of the past two years.Although there is no hurry for hedgers to quickly convert to the fixed rate side, thosepaying float rates should be warned that the days of extremely low borrowing costs arecoming to and end. It is also worth exploring the IRS market on the fixed interest ratesside for tenors not more than 3 years. Currently, 2- and 3- year IRS yields are 2.89% and3.39%, respectively. Historically, the 6-month THBFIX rate is usually higher than thepolicy rate except during the financial crisis in 2008 and the past two years whereThailand invested substantially in Korean government bonds. Hence, we expect that the6-month float rate would at least follow BoT’s policy rate higher towards year end.Fig 1. Swap points (USD/THB forward rate – spot) Fig 2. Interest rate swap Satangs USD/THB Swap point curve % 60 4.0 50 3.5 3.0 40 2.5 30 2.0 20 1.5 10 1.0 0 0.5 1Wk 2Wk 1M 2M 3M 6M 9M 12M Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 17/02/11 5-day ago 1-m ago THBFIX6M 2Y 5YSource: Bloomberg, KBank Source: Bloomberg, KBank111
  • 2. 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. Source: ReutersTable 1. Factors affecting the surge in short-term rates Factors Effects Recent comments from the BoT had been more hawkish, especially after the minutes of January’s MPC meeting showed some members of the MPC contemplated 50bp hike in future policy rate moves. Inflation is the key theme in global recovery now, especially for the Asian economies where output gaps had started to close and many of the developing economies have higher sensitivity to food price inflation as compared to the developed economies. Expectation of monetary tightening The changing of forward rate of USD/THB does not only reflect market’s expectation of USD/THB value in the future alone. In fact, it is used very often to reflect a view on short-term interest rate changes. This is because the THBFIX rates are calculated using 3 variables – the USD Sibor, USD/THB spot rate and USD/THB forward rates. Taking the view that USD Sibor rates would see little change going forward (the Federal Reserve likely to keep its policy rate unchanged for at least another year) but that BoT’s policy rate would rise by 75-100bp in the next 6 months or so, the market quotes higher forward rates for USD/THB, indicating increasing borrowing cost for Thai baht relative to previous periods. The BoT has recently increased its presence in the FX swap market as an alternative to issuing short-term central bank bills to absorb liquidity in the market after intervention in the USD/THB spot market. What the BoT does is putting back U.S. dollar liquidity into the market BoT FX intervention by swapping out USD for THB i.e. sell-buy USD/THB. The result of such transactions is an increase in the demand for buying USD in the future, lifting the forward points or swap points higher. We notice further that the BoT’s foreign exchange forward position continued to increase, although not at a rapid pace compared to last year. The demand for hedging foreign exchange risk by exporters and importers in certain periods can affect movements in the THBFIX rates as well, especially when the sell-buy and buy-sell volume have substantial differences. Exporters would usually have a demand to sell USD forward to hedge baht’s appreciation risk Exporters and Importers while importers would buy USD forward in order to cap the price of the USD when needed to FX hedging purchase products from abroad. In the year 2010, demand from importers had been less due to a clearer declining direction of the USD/THB. However, there had been continued demand from exporters to hedge their revenue in baht terms, providing demand for selling the USD forward and thus helping to keep USD/THB forward rates in range. Investment by Thai residents in Korean bonds and a few other countries’ securities in the past two years had been substantial. When mutual funds perform foreign security-buying and FX hedging transactions, they create a demand for selling USD forward in the market. By saying that, we may have skipped a few steps in asset-swap transaction but all in all, these transactions helped to push USD/THB forward rates lower. (commercial banks borrow USD in Thai residents’ the interbank market for mutual funds and return at a later date, causing an increased demand investment in foreign for buy-sell USD/THB transactions, especially for T/N to 3-month tenors) securities A figure below would show that the pick up in returns from investing in Korean government bonds relative to investing in local government debt had diminished markedly. Hence, local mutual funds had been repatriating the funds without further re-investment, causing a decline in selling USD forward.222
  • 3. Fig 3. Policy rate vs. THBFIX 6m Fig 4. BoT forward position in FX and USD/THB % $ bn 6.0 25 29 repo THBFIX6M 30 5.0 20 31 4.0 15 32 33 3.0 10 34 35 2.0 5 36 1.0 0 37 Feb-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 0.0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 USD/THB (inverted, RHS) BoT Forward position (LHS)Source: Bloomberg,, KBank Source: Bloomberg, KBank Fig 5. Bond-swap spread still negative below 2Y Fig 6. IRS market over the past month bp % % IRS yield curve change bp 80 5.0 5.0 160 60 4.5 140 4.0 40 4.0 120 3.0 100 20 3.5 80 0 3.0 2.0 60 -20 2.5 40 1.0 -40 2.0 20 tenor (yrs) -60 1.5 0.0 0 0.3 0.5 0.8 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 12.0 14.0 15.0 0.1 0.2 0.3 0.5 0.8 1.0 2.0 3.0 4.0 5.0 7.0 12.0 10.0 15.0 20.0 yrs Spread (right axis) Bond curve IRS curve Change (right axis, bps) 17-Feb-11 17-Jan-11Source: Bloomberg, KBank Source: Bloomberg, KBankFig 7. Expected returns in KRW bond investment Fig 8. Market expectation of policy rate hikes in Asia % bp expected change in short-term rate next 12m (bp) CPI % yoy % 9 250 10 8 Philippines 7 200 8 6 5 Indonesia 4 150 6 Thailand South Korea 3 2 100 4 Australia India 1 Taiwan Hong Kong China 0 50 Malaysia 2 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Japan Singapore 1Y Thai bond yield Approximate return on 1Y KRW ASW 0 0Source: Bloomberg, KBank Source: Bloomberg, KBank333
  • 4. Table 2. Monthly Key Economic Indicators Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Nov 10 Dec 10 Jan 11Manufacturing index 194.2 190.1 183.7 201.5 191.2 190.4 190.2 % YoY 14.2 13.1 8.4 8.1 6.0 5.7 -2.5Industrial capacity utilization rate (%) 65.4 64.8 63.6 64.4 63.9 63.6 63.4Retail sales (% YoY) 11.9 12.3 8.5 9.0 5.2 7.8 n.aPassenger car sales (units) 70,557 65,672 65,724 68,261 72,012 78,874 93,122Motorcycle sales (units) 168,389 175,926 153,256 147,932 145,916 154,971 165,658Unemployed labor force (000 persons) 459 346 353 343 355 389 n.aCommercial car sales (units) 1.2 0.9 0.9 0.9 0.9 1.0 n.aConsumer prices (% YoY) 3.3 3.4 3.3 3.0 2.8 2.8 3.0 3.0 core 1.1 1.2 1.2 1.1 1.1 1.1 1.4 1.3Producer prices (% YoY) 11.5 11.1 10.7 9.1 6.3 5.9 6.7 -16.0External Accounts (USD mn, unless specified otherwise)Exports 17,877.0 15,475.0 16,292.0 17,955.0 17,046.0 17,584.0 17,220.0 17,877.0 % YoY 47.1 21.2 23.6 21.8 16.6 28.7 18.6 47.1Imports 15,334.0 16,266.0 15,440.0 14,712.0 14,773.0 17,094.0 15,911.0 15,334.0 % YoY 38.3 36.5 41.8 15.7 14.4 35.0 8.8 38.3Trade balance 2,543.0 -791.0 852.0 3,243.0 2,273.0 490.0 1,309.0 2,543.0Tourist arrivals (000) 953 1,258 1,268 1,220 1,360 1,500 1,840 953 % YoY -0.2 14.7 12.5 1.9 6.3 10.3 9.5 -0.2Current account balance 821.0 -1,001.0 280.0 2,767.0 2,740.0 1,019.0 1,750.0 821.0Balance of payments 2,166 1,412 3,589 4,270 5,822 820 2,263 2,166FX reserves (USD bn) 147.1 151.5 154.7 163.1 171.1 168.2 172.1 147.1Forward position (USD bn) 12.2 11.0 12.1 11.1 12.6 15.3 19.6 12.2Monetary conditions (THB bn, unless specified otherwise)M1 1,180.2 1,173.0 1,181.4 1,175.5 1,202.3 1,235.4 1,302.4 % YoY 15.1 15.8 11.4 11.7 11.4 10.8 10.9M2 10,846.4 10,887.1 10,968.1 11,116.1 11,323.3 11,501.6 11,775.4 % YoY 7.0 8.8 8.5 9.9 11.2 11.2 10.9Bank deposits 9,983.3 9,974.5 10,016.0 10,091.6 10,206.0 10,392.3 10,583.4 % YoY 6.2 7.6 6.6 7.8 8.5 8.1 8.7Bank loans 9,196.7 9,219.7 9,299.8 9,432.7 9,580.3 9,751.1 9,934.4 % YoY 8.5 9.1 9.8 10.8 12.1 12.2 12.5Interest rates (% month end)BOT 1 day repo (target) 1.25 1.50 1.75 1.75 1.75 1.75 2.00 2.25Average large banks minimum lending rate 5.86 6.00 6.00 6.00 6.00 6.00 6.12 6.37Average large banks 1 year deposit rate 0.68 0.98 0.98 1.11 1.11 1.11 1.32 1.51Govt bond yield 1yr 1.56 1.91 1.99 2.01 1.98 2.11 2.38 2.54Govt bond yield 5yr 2.99 3.08 2.69 2.56 2.83 2.98 3.26 3.40Govt bond yield 10yr 3.33 3.44 3.01 3.12 3.18 3.59 3.77 3.85Key FX (month end)DXY US dollar index 86.02 81.54 83.20 78.72 77.27 81.20 79.03 77.74USD/THB 32.45 32.24 31.27 30.35 29.94 30.21 30.06 30.93JPY/THB 36.62 37.29 37.14 36.34 37.18 36.11 37.01 37.60EUR/THB 39.71 42.08 39.65 41.38 41.76 39.22 40.23 42.35Source: Bloomberg444
  • 5. 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.555