.Mean S Multi Asset Strategies KBank                                                                                      ...
Key Parameters & Forecasts at Year-end                                                      2004                 2005     ...
KBank THB NEER Index                                                                                                      ...
Thai inflation parameters                                                                                                 ...
KBank EUR/THB model                                                                 KBank JPY/THB model                   ...
This page has been left blank intentionally666
Are we falling into the lull of optimism?                                                                                 ...
USD/THB, it cuts both waysIn the following, we ponder both cases for further USD/THB downside and upside andsummarized in ...
Fig 6. Greece 10yr bond price, Euro Stoxx bank index                                        Fig 7. Implied recapitalizatio...
Fig 8. EFSF guarantors and their budget / GDP & debt / GDP ratios Country                                  Guarantee commi...
Operation Twist is another factor which had reversed the bearishness of the USDtowards a bullish swing. The September 21st...
This, in it of itself, highlight that the Fed is in no urgency to print more money. Hence itreduces the bearish cue for US...
Fig 15. The BOT is located on the banks of the Chao                      Fig 16. Chao Phraya River System, highlightingPhr...
USD/THB is declining… because?The first Friday is one that is most followed by the markets since it is Jobs Friday. The US...
Beside cheap money with respect to time i.e. interest rates, one way the US can hope torecover is with cheap money with re...
A   Japanization: are we going to see a lost decade in US/EU?       The experience of Japan during the 1990s when the econ...
by recent rise of the dollar. Greece and other PIIGS were reluctant to take a painful wayof the austerity measures. They c...
pay off debt without restructuring the payments with its creditors. Creditors, includingtaxpayers, will need to accept los...
intervened the market by accumulating more foreign reserve so as to slow down the paceof local currency appreciation. This...
Pricing in economic slowdown and policy rate pause          We revised down our target for the policy rate to 3.50% for th...
In any case, we expect that the short-term swap rates would remain capped at low levels (way below policy rate) for up to ...
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
KBank Multi Asset Strategies oct 2011 (English)
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KBank Multi Asset Strategies oct 2011 (English)

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October 2011
Volume 42

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KBank Multi Asset Strategies oct 2011 (English)

  1. 1. .Mean S Multi Asset Strategies KBank Strategies Macro / Multi Asset Are we falling into the lull of optimism? October 2011 Volume 42 Consensus appears to be hoping for the best and not preparing for the worst. It seems that the bitter lessons of 2008/9 have all Kobsidthi Silpachai, CFA –Kasikornbank kobsidthi.s@kasikornbank.com been but forgotten Susheel Narula – KSecurities Calling the USD/THB direction has now become analogous to a susheel.n@kasikornsecurities.com coin toss…and here we provide two sides of the arguments Kavee Chukitkasem – KSecurities USD/THB options are probably the best bet for the next 1 to 2 kavee.c@kasikornsecurities.com months amidst lack of economic clarity compounded by external KResearch political and social abnormality kr.bd@kasikornresearch.com We revised down our target for the policy rate to 3.50% for the end of this year, noting the BoT’s proposed change of inflation target as well as the worsening global conditions due to Disclaimer: This report must be read with the Europe’s debt crisis Disclaimer on page 44 On equities we advise reducing portfolio at current levels. Aim to that forms part of it accumulate shares as we get below 850 but stick to sectors with business oriented towards domestic consumption Strategic Thesis “KBank Multi Asset The experience of Japan during the 1990s when the economy remained stagnant is one Strategies” of the major examples the US and the Eurozone might try to avoid. Still, consensus can now be accessed on wishes for a recovery but the markets might be saying something else. Of late, calling Bloomberg: KBCM <GO> the direction of the USD/THB is likened to a coin toss. Analyzing the economics is already an arduous task in it of itself. Now the political and social dynamics complicate the direction even further: will Greece be the Achilles’’ heel of the euro? Will Troika withhold the next tranche of financial infusion? In light of lack of direction signals, USD/THB options seem to be the best bet amidst a dearth of clarity. We provide thoughts why USD/THB could cut both ways: up or down. We revised down our target for the policy rate to 3.50% for the end of this year, noting the BoT’s proposed change of inflation target as well as the worsening global conditions due to Europe’s debt crisis. The yield curve should continue to stay flat but the uncertainties in global financial markets could lead to lower appetite for duration in emerging market bonds: stay short th duration prior to MPC meeting on Oct 19 . As with other asset classes, volatility in the equity markets will continue. We have set ourselves a one-month window ending in early November before considering the need to change fundamental macro assumptions which will change market outlook. There is a downside risk to our view presently, but we see SET index at 812 to provide strong support. This is based on PBV at 1.5x (fundamentally) and peak-to-trough correction of 30% (technically) – both historically well-tested. Our worst-case has SET index at 730, arrived through stress- testing assumptions on 2012 GDP growth at 1.9% from 5% with increased required risk premium. This worst-case scenario is comparatively better than the worst-case saw in the US sub prime crisis of 2008-9 when the SET went below 400.111 WWW.KASIKORNBANKGROUP.COM
  2. 2. Key Parameters & Forecasts at Year-end 2004 2005 2006 2007 2008 2009 2010 2011E 2012E GDP, % YoY 6.3 4.6 5.2 4.9 2.5 -2.3 7.8 3.8 4.5 Consumption, % YoY 6.2 4.6 3.0 1.6 2.7 -1.1 4.8 3.6 3.8 Investment Spending, % YoY 13.2 10.5 3.9 1.3 1.2 -9.2 9.4 6.3 5.8 Govt Budget / GDP % -0.2 0.3 -0.7 -1.5 -1.0 -5.6 -3.2 -4.0 -4.5 Export, % YoY 21.6 15.2 17.0 17.3 15.9 -14.0 28.5 20.0 10.0 Import, % YoY 25.7 25.8 7.9 9.1 26.5 -25.2 36.8 24.0 12.0 Current Account (USD bn) 2.77 -7.6 2.3 14.1 1.6 21.9 14.8 12.9 8.1 CPI % YoY, average 2.8 4.5 4.6 2.3 5.5 -0.9 3.3 3.8 3.7 USD/THB 38.9 41.0 36.1 33.7 34.8 33.3 31.4 29.0 28.0 Fed Funds, % year-end 2.25 4.25 5.25 4.25 0.25 0.25 0.25 0.25 0.25 BOT repo, % year-end 2.00 4.00 5.00 3.25 2.75 1.25 2.00 3.50 3.50 Bond Yields 2yr, % year-end 2.78 4.94 5.02 3.91 1.98 2.17 2.35 3.60 3.60 5yr, % year-end 4.0 5.3 5.1 4.5 2.2 3.6 2.75 3.65 3.65 10yr, % year-end 4.9 5.5 5.4 4.9 2.7 4.3 3.25 3.80 3.80 USD/JPY 102.5 118.0 119.1 111.8 90.7 93.0 82.0 77 81 EUR/USD 1.36 1.18 1.32 1.46 1.40 1.43 1.40 1.35 1.40 SET Index 668.1 713.7 679.8 858.1 450.0 734.5 1040 812 1320 Source: Bloomberg, CEIC, KBank, KResearch, KSecuritiesKBank Thai Government Bond Rich / Cheap model Bps (actual YTM vs. model) 20.00 15.00 10.00 5.00 0.00 -5.00 -10.00 -15.00 3 mth avg Now -20.00 LB296A LB123A LB133A LB137A LB145B LB14DA LB155A LB15DA LB167A LB16NA LB175A LB183B LB191A LB196A LB198A LB19DA LB213A LB24DA LB267A LB283A LB396ASource: Bloomberg, KBank222
  3. 3. KBank THB NEER Index KBank USD/THB – FX Reserves / USD Majors model Jan 1995 = 100 KBank THB Trade Weighted Index KBank USD/THB model 48 105 46 44 100 + 1 std 42 d 40 95 38 36 90 average 34 32 85 30 80 -1 std dev 28 01 02 03 04 05 06 07 08 09 10 11 12 75 00 01 02 03 04 05 06 07 08 09 10 11 actual modelSource: Bloomberg, KBank Source: Bloomberg, KBankFX reserves – USD/THB model DXY – USD/THB model USD/THB USD/THB since 2001 48 50 46 y = -7.4157Ln(x) + 69.035 44 2 45 42 R = 0.8878 40 40 38 36 35 y = 29.695Ln(x) - 95.504 2 34 R = 0.7685 32 30 30 28 25 26 70 75 80 85 90 95 100 105 110 115 120 125 25 50 75 100 125 150 175 200 225 250 DXY FX reserves to USD/THB mapping current 2011 forecast FX reserves, USD bn DXY to USD/THB mapping currentSource: Bloomberg, KBank Source: Bloomberg, KBankKBank BOT repo model SET forward dividend yield vs. 10yr bond yield % % 5.5 9 5.0 8 4.5 7 4.0 6 3.5 5 3.0 4 2.5 2.0 3 1.5 2 1.0 1 0.5 0 0.0 00 01 02 03 04 05 06 07 08 09 10 11 01 02 03 04 05 06 07 08 09 10 11 12 13 actual model 10yr yields SET forward dividend yieldsSource: Bloomberg, KBank Source: Bloomberg, KBank333
  4. 4. Thai inflation parameters Thai contribution to GDP growth CPI yoy PPI yoy Core CPI yoy % yoy 25% 15 20% 10 15% 5 10% 0 5% -5 0% -10 -5% -15 -10% 1Q09 3Q09 1Q10 3Q10 1Q11 -15% Private consumption Government Consumption Gross fixed capital formation 05 06 07 08 09 10 11 Inventory change Net exports GDP yoySource: CEIC, KBank Source: NESDB, KBankImplied forward curve: swaps Implied forward curve: TGBs % Implied forward rate shifts (IRS) % Bond yields implied curve shifts 3.90 4.25 3.70 4.00 3.50 3.30 3.75 3.10 2.90 3.50 2.70 tenor (yrs) tenor (yrs) 2.50 3.25 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Oct-11 Jan-12 Apr-12 Oct-12 Oct-11 Jan-12 Apr-12 Oct-12Source: Bloomberg, KBank Source: Bloomberg, KBankUS 2yr yields and implied forward US 5yr yields and implied forward 7.0 8 6.0 7 5.0 6 5 4.0 4 3.0 3 2.0 2 1.0 1 0.0 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 2yr yields, % implied forwards 5yr yields, % implied forwardsSource: Bloomberg, KBank Source: Bloomberg, KBank444
  5. 5. KBank EUR/THB model KBank JPY/THB model EUR/THB JPY/THB 43.0 56.0 54.0 41.0 52.0 39.0 50.0 37.0 48.0 46.0 35.0 44.0 33.0 42.0 31.0 40.0 29.0 38.0 36.0 27.0 34.0 25.0 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 actual model actual modelSource: Bloomberg, KBank Source: Bloomberg, KBankKBank GBP/THB model KBank CNY/THB model GBP/THB CNY/THB 5.8 78.0 5.6 73.0 5.4 68.0 5.2 63.0 5.0 58.0 4.8 4.6 53.0 4.4 48.0 4.2 43.0 4.0 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 actual model actual modelSource: Bloomberg, KBank Source: Bloomberg, KBankKBank THB/VND model KBank AUD/THB model THB/VND AUD/THB 800 35.0 750 700 33.0 650 31.0 600 29.0 550 500 27.0 450 25.0 400 350 23.0 300 21.0 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 actual model actual modelSource: Bloomberg, KBank Source: Bloomberg, KBank555
  6. 6. This page has been left blank intentionally666
  7. 7. Are we falling into the lull of optimism? Kobsidthi Silpachai, CFA - KasikornbankIf we look at consensus forecasts for 2011 and especially 2012, economists are not kobsidthi.s@kasikornbank.compaying heed to Michel de Notradamus’s prediction that the world as we know it will nolonger exist post December 21st, 2012. According to the IMF’s latest forecasts, the global Nalin Chutchotitham – Kasikornbank nalin.c@kasikornbank.comeconomy is to expand close to 4% for 2012 while Thailand is see a 4.8% pick up ineconomic activities. Amonthep Chawla, Ph.D. – Kasikornbank amonthep.c@kasikornbank.comAn argument against such optimism is gaining momentum as financial market conditionslooks and feels more and more of a de javu of 2008. Prior to 2008, the US yield curvewas flat and or inverted most of 2006 and 2007. In early 2008, Bear Stearns a globalinvestment bank which had a peak market capitalization of USD 24.88bn collapsed andwas bought by JP Morgan. On the macro front, non-farm payrolls had peaked in January2008 (138 million) and were on a substantial decline leading to a surge on mortgagedelinquencies.Fig 1. IMF forecast for global economic growth... Fig 2. IMF forecast for Thai economic growth 6 9 8 5 7 4 6 5 3 4 3 2 2 1 1 0 0 -1 -2 -1 -3 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 World economic growth, % IMF projections, % Thai economic growth, % IMF projections, %Source: IMF Source: IMFBeside these ominous sign posts, one barometer of a prelude towards a full blownfinancial crisis is proxies of credit spreads. Here we are referring to LIBOR OIS spreads.These LIBOR OIS spreads (short for Overnight Index Swaps) are the difference betweeninter-bank funding benchmarks such as 3mth LIBOR minus a geometric estimate ofcentral bank funding rates. The rule of thumb is, the higher the spread, the tighter thecredit conditions in the inter-bank marketFig 3. US Libor OIS Fig 4. EU Libor OIS 400 200 350 180 160 300 140 250 120 200 100 150 80 60 100 40 50 20 0 0 02 03 04 05 06 07 08 09 10 11 02 03 04 05 06 07 08 09 10 11 US LIBOR OIS (Overnight Index Swap), bps Euro LIBOR OIS (Overnight Index Swap), bpsSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank777
  8. 8. USD/THB, it cuts both waysIn the following, we ponder both cases for further USD/THB downside and upside andsummarized in fig 5.Fig 5. USD/THB, it cuts both ways The case for lower USD/THB The case for higher USD/THB The US economy is still floundering. With unemployment very Bureaucracy of the EU system limits the speed of how elevated at 9%+, economic stimulus no doubt is needed European authorities can effectively respond and resolve the Fiscal constraints means that stimulus in the form of crisis and allows the Eurozone to implode into a full fledge expansionary fiscal policy is not an option sovereign domino defaults and bank runs / closures …hence QE3, 4, …. is still needed…..meaning the Fed will Risk aversion kicks in and investors further reduced printing more US dollars to monetize and reduce their investment positions in all sorts of risk asset classes indebtedness including emerging markets equities and bonds The European authorities, despite having demonstrated Higher risk perception of the EUR will prompt a shift of shortcoming of leadership, solidarity and efficiency in dealing reserves away from the 17 nation currency (market share of with the sovereign debt / banking crisis, is able to prevent or 27%) and towards the US dollar (market share of 60%) postpone a full blown crisis The Fed is contented with just the 2011 version of “Operation Thailand is seen to post current account surpluses, meaning Twist”. This means that the Fed will not expand its balance sellers of USD/THB outnumber buyers of USD/THB at the sheet and slows down the pace of US dollar printing i.e. M1 current level money supply China proceeds with CNY appreciation. This allows regional The Bank of Thailand adopts a wait and see stance on currencies including the Thai baht to appreciate as well monetary policy amidst lack clarity on the global economic without significant implications on competitiveness front. This reduces support for the baht as policy rates stay Thai baht remains undervalued e.g. the Economist Big Mac at 3.50% index estimates Thai baht is 42.3% undervalued relative to the US dollar.Source: KBank Source: KBankUSD/THB elevating higher… because?In May 2010 and onwards, Greece, Ireland and Portugal sought financial bailoutpackages from other Eurozone countries and the International Monetary Fund (IMF).More than a year afterwards, much of the pledges of austerity, especially for the case ofGreece were empty promises. With cross holdings of various Eurozone governmentbonds by various Eurozone commercial banks, the deterioration in fiscal health ofgovernment inadvertently meant the demise of commercial banks. If one was to make ananalogy what CDOs (collateralized debt obligations) did to American and other banksworldwide post 2008 to now, it would be the toxic bonds of the weaker links (such as thePIIGS group) in the EU.Fig 6 shows that as Greek bond prices fall, it will take the Euro Stoxx bank index with it.The Euro Stoxx bank index comprises of 32 European banks with a cumulative totalasset of EUR 5 trillion versus the Eurozone GDP of EUR 2.9 trillion. As the market valueof these banks equity falls below their book value, it provides a estimate of how muchrecapitalization is needed. On figure 7, the implied recapitalization needs of these 32banks are about EUR 367bn, currently. This is a moving target, as market expectationschanges. Another point that can be taken from this is that, investors of banks have moreor less have withdrawn their money in the form of equity. The question now is whetherother sources of funds will withdraw their deposits i.e. bank runs.888
  9. 9. Fig 6. Greece 10yr bond price, Euro Stoxx bank index Fig 7. Implied recapitalization of Euro Stoxx banks 110 260 600,000 100 240 90 400,000 220 80 200 200,000 70 180 60 0 160 50 00 01 02 03 04 05 06 07 08 09 10 11 40 140 -200,000 30 120 -400,000 20 100 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 -600,000 Greece 10yr bond, % of par (left) Euro Stoxx Bank index (right) Euro Stoxx bank index, market cap less book value implied recapitalization, EUR mnSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankWhat is the European immediate response, attempting to contain the crisis? Four littleletters: EFSF with a big task. EFSF is short for “European Financial Stability Facility”.EFSF is similar in concept to our FIDF (Financial Institution Development Fund). Duringthe 1997 crisis, the FIDF attempt to assuage bank runs on deposits. But when the dustsettled, some 56 finance companies had to close and a handful of banks had to benationalized to avert calamity.Recently, the EU authorities are pushing to expand the war chest of the EFSF, fromEUR440bn to around EUR780bn, which represents the guaranteed commitments bycountries within the Eurozone. The idea being, the EFSF would raise funding in themarket, which it has so far sold 3 tranches for a total of EUR13bn, and on-lend to entitiesit deems needed financial assistance. However in the event that the EFSF could nothonor its own financial obligations, the countries as shown in fig 8, would have to honorthe EFSF on its behalf. Imagine a case where if the EFSF lent money to France. Francewas unable to pay back the EFSF and causing the EFSF to be unable to pay back itscreditors. The creditors can then demand payments from say, Germany. The unfortunatething is that most of these countries pledging to back the EFSF are not in a healthy fiscalposition to back up their commitments in the first place. Even the market perceivedmighty economy of Germany already has a debt / GDP ratio of 83%, well above theMaastricht Treaty limit of 60%. This questions the viability of the EFSF as it is really theweak nations trying to save themselves. It would stand a higher probability of success ifAsian investors / central banks / sovereign wealth funds are lured into buying the EFSFbonds despite the fact that it is backed by near bankrupt nations.999
  10. 10. Fig 8. EFSF guarantors and their budget / GDP & debt / GDP ratios Country Guarantee commitments, EUR mn budget / GDP, % public debt/ GDP, % Kingdom of Belgium 27,032 -4.1 96.8 Federal Republic of Germany 211,046 -3.3 83.2 Ireland 12,378 -32.4 96.2 Kingdom of Spain 92,544 -9.2 60.1 French Republic 158,488 -7.0 81.7 Italian Republic 139,268 -4.6 119.0 Republic of Cyprus 1,526 -5.3 60.8 Grand Duchy of Luxembourg 1,947 -1.7 18.4 Republic of Malta 704 -3.6 68.0 Kingdom of the Netherlands 44,446 -5.4 62.7 Republic of Austria 21,639 -4.6 72.3 Portuguese Republic 19,507 -9.1 93.0 Republic of Slovenia 3,664 -5.6 38.0 Slovak Republic 7,728 -7.9 41.0 Republic of Finland 13,974 -2.5 48.4 Hellenic Republic 21,898 -10.5 142.8 Republic of Estonia 1,995 0.1 6.6 Total Guarantee Commitments 779,783Source: http://www.efsf.europa.eu/about/index.htmThis hence leads to the lingering-in- the-back-of- market’s mind, will the euro survive. Inhis last ECB meeting, Jean Claude Trichet said that the euro will still be around in 10years time. But what if it isn’t and the market has to go back to the US dollar, despite allof its imperfections? As the EUR arrived on the FX scene Asian central banks which hadthe Deutschemark as one of its reserve currency had to trade it in for the Euro. At thetime of fixing, it was 1.95583 DEM to 1 EUR. Fig 10 shows that EUR’s market share rosefrom 18% to 26%+ at the expense of a lower USD market share slipping from 72% to60%.Fig 9. Market share of fiat FX currency reserves Fig 10. USD, EUR market share in FX reserves GBP Other Worlds breakdown of reserve currency CHF 4.2% 4.9% 74 30 0.1% 72 28 JPY 3.9% 70 26 68 24 66 22 EUR 26.7% 64 20 USD 60.2% 62 18 60 16 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 % holding in USD (left axis) % holding in EUR (right axis)Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank101010
  11. 11. Operation Twist is another factor which had reversed the bearishness of the USDtowards a bullish swing. The September 21st FOMC statement was US dollar bullish as: To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.The buying and selling of equal amounts equates to no significant expansion in the Fed’sbalance sheet. Hence the exercise is merely a sector rotation, from the short end of thecurve to the long end of the curve. This is a means of reducing the gapping as to forcecommercial banks to switch from making money from taking duration risk and towardtaking credit risk. Operation Twist is to crowd out the non-private sector simulativeactivities i.e. borrowing from the Fed and lending to the US Treasury instead of lending tothe private sector. Fig 11 shows that Fed Funds rate and the shape of the yield curvemove in opposite directions, that is, as Fed Funds rises, the yield curve steepens.Whereas when the Fed Funds falls, the curve flattens. The Fed has flagged its intentionto keep short rates where they are i.e. low. Hence to flatten the yield curve to encouragebanks to take credit risk, the Fed has to buy longer dated maturity treasuries.Fig 11. Fed Funds rate, shape of the US yield curve Fig 12. US bank’s loans and leases, stagnating bps % 8,000 350 7 7,000 300 correlation is -93% 6 6,000 250 5 5,000 200 150 4 4,000 100 3 3,000 50 2,000 2 0 1 1,000 -50 00 01 02 03 04 05 06 07 08 09 10 11 - -100 0 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 US 10yr yield less 2yr yield, left Fed Funds, right Loans and leases, USD bnSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank111111
  12. 12. This, in it of itself, highlight that the Fed is in no urgency to print more money. Hence itreduces the bearish cue for USD/THB.Fig 13. y = f(x), USD M1 money supply as a function of Fig 14. y = f(x), USD/THB as a function of USD M1Fed’s balance sheet money supply USD M1 money supply, USD bn 2200 USD/THB 48 2100 46 2000 44 y = -0.0188x + 65.37 2 y = 0.0002x - 0.4615x + 1711.7 42 1900 2 R = 0.9398 2 40 R = 0.8832 1800 38 1700 36 34 1600 32 without Sept 2006 to Dec 2008 period 1500 30 2108.8 1400 28 26 800 1000 1200 1400 1600 1800 2000 2200 2400 2600 2800 3000 Feds balance sheet, USD bn 1000 1100 1200 1300 1400 1500 1600 1700 1800 1900 2000 2100 2200 USD M1, bnSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankThailand’s Katrina / 3-11 or our 10-11The current unfolding events regarding the floods that have devastated about 59provinces out of 77 province is similar to how Katrina impacted the US Gulf coast areasor what Japan faced following the 3-11 earthquake / tsunami.Economic and social losses are at the moment are difficult to estimate. Finance MinisterThirachai Phuvanatnaranubala has put losses at about THB 60bn while the NationalEconomic and Social Development Board (NESDB) have estimates the losses at THB80-90 bn. As the Bank of Thailand is located at the banks of the Chao Prahya river, theCentral Bank is to have a great sense of urgency to adopt a wait and see stance as bothinternal and external environment are in an extreme state of flux. This means that carrytrades by shorting the US dollar and a long position in Thai baht is less attractive incomparison to expectations of a hawkish Bank of Thailand and a dovish Fed. The Veniceof the East (Bangkok is to face the most critical periods of flooding during October 16th to th18 ) given the convergence of a high tide, more run off from the dams up North andpossibly more rainfall from new depression systems.121212
  13. 13. Fig 15. The BOT is located on the banks of the Chao Fig 16. Chao Phraya River System, highlightingPhraya river impacted areasSource: Google Maps Source: wikipediaFig 17. Policy rates, TH vs. US Fig 18. Implied forward rates, 1yr rate, 1yr from now % change : 1yr rate, 1yr from now 7 0.50 6 0.40 5 0.30 4 0.20 3 0.10 0.00 2 -0.10 US CH ID MY UK KR EU SG TH 1 -0.20 0 -0.30 00 01 02 03 04 05 06 07 08 09 10 11 % change : 1yr rate, 1yr from now BOT repo Fed FundsSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank131313
  14. 14. USD/THB is declining… because?The first Friday is one that is most followed by the markets since it is Jobs Friday. The USlabor department reported that September created about 103k jobs which were higherthan what economists had penciled in at 60k. The market seems to be contented with thereport with 10yr bond yields climbing about 2% post the Fed’s announcement ofOperation Twist. Still this is hardly something to celebrate about since while the USeconomy might have recovered, but the jobs market (one of the two Fed mandates) ishardly in equilibrium. At the peak of the US economic boom, the total number ofAmericans working excluding the agricultural sector was 137,996k whilst September’sreading is 131,334k.Fig 19. US non-farm payrolls change vs. consensus Fig 20. Total non-farm payrolls 140,000 000 800 138,000 600 400 136,000 200 134,000 0 -200 132,000 -400 -600 130,000 -800 128,000 -1000 00 01 02 03 04 05 06 07 08 09 10 11 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 non-farm payrolls, k non farm payroll - actual surveySource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankHence, there is no double dip for the US jobs market, since it had never recovered. Manyconsidered that this recent recovery was a “jobless” recovery, which is ratherunsustainable since the US economy is largely driven by consumption. No jobs = nowages = no income = no spending = no growth. Therefore, it can not be stressed enoughthat the economy has to grow in order to accommodate the jobs market. Fig 21 maps thechange in non-farm payrolls as a function of change in nominal GDP, which suggests thatthe US economy needs to grow at least 1% just to keep non-farm payrolls at a zerochange. Unfortunately, stimulus via expansionary fiscal policy is no longer an option asthe Eurozone crisis will attest to or else we will hear about the US sovereign debtcrisis…again.Fig 21. y= f(x), change in non-farm payrolls as a Fig 22. US debt to GDP ratio, IMF estimatesfunction of change in US nominal GDP change in non-farm payrolls 120 1.0% 110 100 90 0.5% 80 70 0.0% 60 -2.5% -2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 50 -0.5% 40 change in nominal GDP 30 20 -1.0% 10 y = 0.5025x - 0.0048 2 0 -1.5% R = 0.6318 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 since 2000 -2.0% US GDP % IMF projectionsSource: Bloomberg, CEIC, KBank Source: IMF141414
  15. 15. Beside cheap money with respect to time i.e. interest rates, one way the US can hope torecover is with cheap money with respect to other currencies i.e. foreign exchange rate.Fig 23 states our case, mapping the US dollar on a trade weighted basis versus the USGDP (chain weighted, real). The map suggests that as dollar weakens it will besupportive of US economic growth. For every point reduction in the US dollar, it shouldgenerate real economic growth of USD 54 bn, vice versa.This is why the legislative branch of the US government is looking towards a veryprecarious maneuver by drafting the “anti China currency bill” which is likely to spark atrade war. One bitter lesson from the Great Depression was that protectionism and tradebarriers made matters worse and sank the global economy ever further. Fig 24 states thecase for the currency bill, which shows that as the US sinks further into a trade deficitwith China, the number of non-farm payrolls in the manufacturing also falls.Fig 23. y= f(x), US GDP as a function of trade weight Fig 24. US trade balance with China & US non-farmdollar payrolls – manufacturing sector US chain weighted real GDP, US bn 0 19.0 13500 -50 18.0 -100 17.0 13000 y = -49.137x + 16851 16.0 74, 13,272 2 -150 12500 R = 0.8366 15.0 -200 14.0 12000 -250 13.0 ρ = 92% -300 12.0 11500 -350 11.0 11000 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 10500 US trade balance with China, 12mth moving sum, USD bn (left axis) 60 70 80 90 100 110 120 130 US non-farm payrolls, manufacturing, mn (right axis) DXY, US dollar indexSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankThe market expectation is for further downside for the USD/CNY is still tepid since thespot and the 12mth NDF (non-deliverable forward) is about the same levels. Therefore ifthis bill truly picks up momentum, such expectations are likely to change for furtherdownside for USD/CNY as well as USD/THB as shown by the mappings on fig.26Fig 25. USD/CNY 12mth NDF, USD/THB Fig 26. USD/CNY 12mth NDF, USD/THB mapping USD/THB spot 48 7.4 37 46 7.2 36 y = 6.3239x - 9.664 correlation coefficient = 0.93 44 2 35 R = 0.9411 7.0 42 34 40 6.8 33 38 6.6 36 32 6.4 31 34 6.2 32 30 6.348, 30.88 30 6.0 29 28 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 6.0 6.5 7.0 7.5 8.0 8.5 9.0 USD/CNY NDF USD/CNY 12mth NDF (left axis) USD/THB spot (right axis)Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank151515
  16. 16. A Japanization: are we going to see a lost decade in US/EU? The experience of Japan during the 1990s when the economy remained stagnant is one of the major examples the US and the eurozone might try to avoid The US and the eurozone had better take a serious measure to solve their economies unless they will end up like Japan which its government was reluctant to do anything except printing more money The US could employ fiscal policy and reform its economy to lean toward more exports; meanwhile, debasing the dollar is also an important tool to lower its debt obligation The tangible solution for the eurozone is to take a painful but meaningful step; default is already out of the question as Greece is seen unable to pay off debt without restructuring the payments with its creditors The conflict between the US and China over the yuan appreciation will remain on-going and will be a part of the global economic volatility for the following yearDon’t learn from the Japanese modelThe experience of Japan during the 1990s when the economy remained stagnant, calledlost decade, is one of the major examples the US and the eurozone might try to avoid.The cause of the economic crisis in the US and Japan was similar: the burst of assetprices. The stock market clashed in 1990 in Japan while the housing prices burst in 2008in the US. Both the events led to banking crises. The governments took part in stabilizingthe financial market by injecting a great deal of money to keep banks alive. However,loosening monetary policy led to an increase in money supply and a lower interest rate.Liquidity trap was a major challenge in economic recovery as borrowers were reluctant toinvest depite low interest rate. Bond issuance caused an increase in public debt, whichled to a question on fiscal sustainability. Consequently, both the US and Japan’sgovernments were downgraded. How about the eurozone? The cause of the upcomingcrisis was from an increase in public participation in solving financial crisis in 2008 whenbanks were unwilling to lend to another bank for fear of bankrupcy as seen in LehmanBrothers. Governments in the eurozone stimulated the economies by injecting money tothe system, which subsequently was developed into another form of crisis: sovereigndebt crisis. When the public becomes the problem the economies have no one left torescue them. Japan, US and the eurozone have something in common which is theproblem of huge public debt. How can the US and the eurozone avoid following theJapan’s foot step that caused the economy to stay stagnant for a decade?Actually, the way the US and the eurozone have been solving their economies isresemble to what Japan did two decades ago, which is by procrastinating the problem.No one has been taking a problem seriously. We have not yet seen a critical reform inany of these economies. Economic structure has remained the same prior to the crises.American consumers still enjoy incuring consumer’s debt while exports are discouraged161616
  17. 17. by recent rise of the dollar. Greece and other PIIGS were reluctant to take a painful wayof the austerity measures. They could not meet the target that they promised earlier.German and France have kept bailing out these countries for fear if these governmentsdeclare default. German and French banks would be in trouble as they hold a great dealof sovereign bonds. Therefore, the solution in the past is very simple: let’s hope there willbe a mirable! Of course, there is no economic miracle to solve the sovereign debtproblem in PIIGS. The longer they wait, the more painful creditors will encounter whenfacing with hair cut as the size of the loan has grown bigger due to series of bail-out. TheUS and the eurozone had better take a serious measure to solve their economies unlessthey will end up like Japan which its government was reluctant to do anything exceptprinting more money. Don’t forget that Japan was in a better position than the US andperhaps the eurozone on the ground that Japanese are net savers and exports fromJapan are more competitive.Fig 27. Growth of money supply in Japan Fig 28. Growth of money supply in the US % yoy Japan money supply % yoy US money supply 35 25 30 20 25 20 15 15 10 10 5 5 0 0 -5 -5 May-01 May-02 May-03 May-04 May-05 May-06 May-07 May-08 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Growth of M1 (% yoy) Growth of M1 (% yoy)Source: Bloomberg, KBank Source: Bloomberg, KBankIs there a way out?Yes, of course. There are solutions to solve economic problems in the US and theeurozone. For the US, monetary policy is doomed. Liquidity trap of low interest rate isapparent. Therefore, the remaining tool is the fiscal policy. It is still hard to imagine thatthis is a solution, especially after the political tension between the Democrats and theRepublicans over raising the debt ceiling and cutting budget deficit. However, the US stillhas room to increase government spending to create jobs and private consumption.Without political competition, the US government still has one powerful tool left. By doingso, it is important that the US continue reforming its economy to lean toward moreexports. Meanwhile, debasing the dollar is also an important tool to lower its debtobligation.How about the eurozone? Politicians in the eurozone have been denying the truth thatthey cannot rescue PIIGS. If they continue injecting more money to rescue Greece andothers, they will end up transfering money to PIIGS or bailing out their own banks. Eventhey continue pumping more money, it will end up hurting PIIGS more. It is noted that acountry with larger debt obligation is likely to grow at a slower pace than before.There is a negative relationship between debt burden and growth. When public debt risessharply, investors are likely to be worried about fiscal sustainability, which eventuallyleads to banking crisis. Banks can be punished from buying government bonds. Higherpublic debt leads to higher bond payments, which take a bigger portion of governmentbudget. The government is seen to have fewer resources to invest. Consequently, a slowgrowth of capital stock is unable to induce higher labor productivity, which leads to slowerpace of economic production. The tangible solution for the eurozone is to take a painfulbut meaningful step. Default is already out of the question as Greece is seen unable to171717
  18. 18. pay off debt without restructuring the payments with its creditors. Creditors, includingtaxpayers, will need to accept losses. The remaining questions are whether othermembers of PIIGS will default and how much banks will need to recapitalize. Answers forthese questions remain unknown as it depends on how much investors would continueselling stocks and depositors could be panic and start to withdraw money from banks thathave high exposure to PIIGS’s debt. It is unavoidable that banks in the eurozone will endup being downgraded if they fail to recapitalize or prevent the bank run. Fig 30. Claims on PIIGS’s public debt by French andFig 29. Japanization in the US and the eurozone German banks USD bn Foreign claims on public debt by nationality of reporting banks 250,000 200,000 150,000 100,000 50,000 0 Dec-11 Mar-11 Dec-11 Mar-11 Dec-11 Mar-11 French banks German banks Other banks Portugal Ireland Italy Greece SpainSource: The Economist, July 30, 2011 Source: Bloomberg, KBankDexia and more to comeDexia could be viewed as a sign of an early stage of banking crisis in the eurozone.Dexia is a Franco-Belgian bank that is being in trouble for its high exposure to Greece’sdebt. Dexia used short-term funding to finance long-term lending; hence, credit dried upduring the eurozone debt crisis. Investors are concerned about the bank’s financial healththat has led to a sharp decline in bank’s capital. French-Belgian governments tried torescue Dexia either by injecting capital through the EFSF and ECB similarly to the US’TARP in 2008, yet the plan was dropped as it would deplete resources from EFSF whichshould be used as the last resort. France and Belgium helped bail out Dexia, yet failed toseparate bad bank. Subsequently, Dexia was agreed to the nationalization of its Belgianbanking division, which was followed by a warning by Moody’s that the Belgium’s Aa1government bond ratings could fall with this bail out plan. Based on this example, we willsee larger public intervention on bailing out troubled banks, either by nationalizing banksor injecting more capital to prevent bank run. If banks collapse, financial turmoil in theeurozone will prevail. It is likely to see slower growth in the eurozone for the next fewyears until banks have successfully recapitalized to gain financial health. In addition,fiscal reform is necessary to allow the governments to reduce public debt for fear ofdisrupting economic growth in the future.BRICS and world economic recoveryBRICS, namely Brazil, Russia, India, China and South Africa, are emerging economiesthat have been enjoying high economic growth. During the economic crisis in 2008,BRICS’s economies grew remarkably despite a fall of the global demand. Major factorsare that they relied on their domestic consumption and investment to generate growth.Can they revive the ailing global economy again if we all fall into trouble? This time theanswer is full of uncertainty. After the sub-prime crisis, the Fed introduced QE1 and QE2,which caused rapid capital flows to BRICS and other regions. Capital flows has led to anincrease in the demand for local currencies, causing stronger exchange rate versus theUS dollar. In order to maintain competitiveness in exports, several central banks181818
  19. 19. intervened the market by accumulating more foreign reserve so as to slow down the paceof local currency appreciation. This attempt has drawn attention to currency war whereone country has tried to make its exchange rate under-valued so as to gain greatercompetitiveness against others. The US is seen hostile to China for making the yuanartificially under-valued, threatening to pass a currency bill to punish China. The USclaimed that it could generate more jobs if the yuan has been more appreciated.However, China warned the US that the currency war could lead to a trade war. Thisconflict will remain on-going and will be a part of the global economic volatility for thefollowing year.191919
  20. 20. Pricing in economic slowdown and policy rate pause We revised down our target for the policy rate to 3.50% for the end of this year, noting the BoT’s proposed change of inflation target as well as the worsening global conditions due to Europe’s debt crisis Given the new policy target and the BoT’s forecast of decelerating headline inflation rate, there should be less pressure to call for further hikes Bond yields had a volatile third quarter but basically the yield curve remained flat Foreign investors turned net-sellers of Thai bonds for the first time in months and risks of further sell-offs continue although we do not expect such an outcome unless European debt crisis turned into a global financial crisis of similar impact as the crisis in 2008 Q1 bond supply capped by delays in fiscal budget, high treasury cash balance, and P/N substitution FY2012 bond supply plan changed slightly : more long-term bonds, lower 3-year bonds We continue to see a flat yield curve going forward but the uncertainties in global financial markets could lead to lower appetite for duration in emerging market bonds: stay short duration Market update – September and October interest rate movements During the past 3 weeks or so, the situation in Europe with regards to Greece’s debt crisis had worsened drastically, driving local bond yields and the IRS rates into different directions. The government yield curve shifted upwards as a result of foreign investors’ sell-off in emerging market assets while the IRS rates fell, following the short-dated THBFIX rates on the back of USD liquidity concern in the global markets. During the first week of October, such trends started to revert: bond yields started to fall slightly while IRS rates saw less downward pressure from the declines in swap points.Fig 1. Government bond yield curve rebounded Fig 2. Movements of IRS rates % Government bond yield curve % 4.00 3.83 5.0 3.81 3.82 3.77 3.80 3.69 4.5 3.63 3.61 3.62 3.56 3.58 3.67 3.69 3.64 3.64 4.0 3.60 3.55 3.55 3.53 3.53 3.53 3.48 3.5 3.40 3.45 3.0 3.38 3.41 3.41 3.4 3.36 3.33 3.35 3.20 3.32 3.31 2.5 3.00 2.0 1y 2y 3y 4y 5y 6y 7y 8y 9y 10y Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 07-Oct-11 22-Aug-11 26-Sep-11 TTM IRS 2Y IRS 5Y IRS 10Y repoSource: Bloomberg, KBank Source: Bloomberg, KBank 2020 20
  21. 21. In any case, we expect that the short-term swap rates would remain capped at low levels (way below policy rate) for up to the end of December, given the market’s expectation that the Bank of Thailand (BoT) would not increase the policy rate further and the ongoing concerns about USD liquidity amid the tightness of USD funding conditions in Europe. Hence, we iterated our view last month that it is still a good time for the corporate sector to hedge borrowing costs but there is no hurry in doing so.Fig 3. 6m swap points and 6m THBFIX rate Fig 4. Bond-swap spreads picked up slightly satangs % bps 50 3.75 80 60 45 3.50 40 40 3.25 20 35 3.00 0 -20 30 2.75 -40 25 2.50 -60 20 2.25 -80 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 USD/THB 6m forward point 6M THBFIX 2Y bond-swap spread 5Y bond-swap spread 10Y bond-swap spreadSource: Bloomberg, KBank Source: Bloomberg, KBank Foreign investors had turned net-sellers of local THB fixed income securities for the first time in more than a year during September. During the same month, foreigners also pulled out of the local stock market (net-sell USD 541.5mn) and the USD/THB turned 4.01% weaker in the month of September before rebounding by nearly 1.0% in October. Expectations that the Thai baht would not perform in the near-term also reduce foreigners’ reinvestment into short-dated debt. As a result, foreign investors’ net holding of THB fixed income securities fell from THB 438.6bn at end August to THB 434.2bn at end September and further to THB 425.6bn as of October 7th. Furthermore, we note as well that foreigners’ holding of THB bonds had climbed by THB 300bn in a short 12 month period from THB 150bn back in September 2010. This reflects substantial risk of sudden capital outflow should foreign funds liquidate THB bonds in the face of another outbreak of global financial crisis. If that worst case scenario does not happen, we expect that emerging market bonds would continued to see positive demand, given their rising significance in the global markets and the stronger fiscal positions of emerging market economies.Fig 5. Foreign holding position declined Fig 6. Foreign outright trade (net-purchase, monthly) Bt bn THB bn 500 180 163 450 160 400 140 127 128 350 120 300 100 84 73 71 79 up till 250 80 200 45 Oct 7th 60 40 150 28 40 16 19 100 50 20 3.7 - 0 -20 -1.5 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Sep Nov Jan Mar May Jul Sep foreign holding in Thai fixed income, THB bn foreign net-buy in THB bonds (billion baht)Source: PDMO, KBank Source: PDMO, KBank 2121 21

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