The document discusses recent economic data that has improved optimism about the US economic recovery. It notes that manufacturing data and employment data like the ADP report suggest non-farm payrolls could be higher than expected in December. However, it also notes the view that more quantitative easing is still needed given unemployment remains high. While the dollar may benefit short-term from better data, the document argues the dollar index may be capped around 80.53 based on their model. It also discusses that Thailand is likely to continue running large current account surpluses, which typically puts downward pressure on the USD/THB rate. Their model suggests a 4Q11 target of 28.00 for USD/THB.

1. .Mean S FX & Rates Strategies
KBank Economics /
Strategy
Jobs Friday…more M1 = more jobs…or just lower USD?
FX / Rates
6 January 2011
Holiday mood hangover is putting a positive spin on sentiment
for the time being
Kobsidthi Silpachai, CFA
Bullish ADP reading suggest Friday’s non-farm payrolls could be kobsidthi.s@kasikornbank.com
around 323k
Nalin Chutchotitham
The glass half empty view is that Fed’s minutes indicate the nalin.c@kasikornbank.com
need for QE2 persists despite the higher inflation expectations
by the TIPS market
Hence the US will keep QE while Asia goes QT, that is
quantitative tightening
Election year syndrome reinforces the sustained probability of
current account surpluses and hence we retain our 4Q11
USD/THB target of 28.00
Unfortunately we ponder that the continued current account Disclaimer: This report
surpluses is good for the Thai baht, but it is not good for the Thai must be read with the
Disclaimer on page 10
citizen
that forms part of it
KBank Capital Market
Research can now be
accessed on Bloomberg:
Fig 1. The wild ride for US jobs ….and recovery in 2011
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2. The exhubrant optimism from the New Year fesitivities
Economic data points of late spurred hopes that the business sector is recovering.
Seems that the New Year might be bringing new hope with the US ISM Manufacturing
index (The Institute of Supply Management’s purchasing manager’s index) has continued
to hover about the 50 boom / bust line for 17 consecutive months. The index helps to
measure how the manufacturing sector is performing. If it is reported to be more than 50,
it generally means that the sector is expanding and if the reading is less than 50, the
sector is contracting. But does an expanding manufacturing sector automatically means
an expanding job market? Fig 3 seems to suggest a good probability. Since 2000, the
correlation between ISM manufacturing and monthly changes in non-farm payrolls is
around 75%, which supports a good case for such an argument.
Fig 2. ISM manufacturing has been over 50pts for the
Fig 3. ISM manufacturing & BLS non-farm payrolls
past 17 consecutive months
70
65 800
65 600
60
60 400
55
55 200
50 0
50
45 -200
45
-400
40 40 ρ = 75%
-600
35 35 -800
30 30 -1000
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 00 01 02 03 04 05 06 07 08 09 10
ISM manufacturing ISM manufacturing, left axis non-farm payrolls, right axis
Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank
The recent upside surprise to the markets was the Advance Data Processing (ADP) –
employment change for the month of December 2010 which printed at 297k against the
consensus of 100k. This is helping to boost the dollar’s appeal for the time being and
makes the bulls on the US economic recovery look good. Fig 4 adds to the argument,
which shows that ADP might explain about 88% of the variance of the Bureau of Labor
Statistic’s (BLS) version of the non-farm payrolls. The regression equation would suggest
that if December’s reading for ADP was 297k, the BLS reading should be about 323k.
Fig 4. ADP & BLS non-farm payrolls mapping Fig 5. KBank DXY model
latest data point mapping
600 90
y = 1.0287x + 17.698 88
2
400 86
R = 0.8883 84
200
82
ADP employment change, k 80
0
78
-1000 -800 -600 -400 -200 0 200 400
-200 76
74
-400 72
-600 70
Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul-
-800 07 07 08 08 09 09 10 10 11 11 12 12
-1000
Bureau of Labor Statistics, non-farm payrolls, k actual model
Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank
While the vogue is for dollar bullishness, some commentators say that one data point
doesn’t make a trend. Unless the consensus is totally convinced that the recovery from
manufacturing continues to transmit to the jobs market, the DXY – US dollar index might
not go far. Our DXY model based on consensus inputs for EUR/USD, USD/JPY,
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3. GBP/USD, USD/CAD, USD/SEK, USD/CHF would indicate that DXY target for 1Q11 is
around 80.53. The “glass half empty” view would argue that the unemployment rate is not
somewhere near 5% but near 10%. Try telling those who have been out of a job for the
past two years that the economy is recovering…and chances are, the optimist will get a
vulgar gesture. Psychologically, pain has a higher magnitude than gain. Ever wonder why
bear markets tend to last longer than bull markets?
Fig 6. Bloomberg’s Taylor Rule Function
Source: Bloomberg, CEIC, KBank, Cagle.com
Again, we would like to present the Taylor rule as a guide and as a reminder the severity
of the need for continued accommodative US monetary policy. Based on the rule and
assertion of conducting monetary policy with only one tool i.e. the Fed Funds rate, the
appropriate Fed Funds rates should be a negative 2.6% based on a 0.80% core PCE
(proxy for inflation) and unemployment of 9.8% (proxy for being above or below trend
economic growth). This reinforces the fact that other forms of easing monetary policy is
needed to supplement a low policy rate since policy rates can not fall below 0%.
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4. The local catalysts for USD/THB
November’s data points for Thailand continued to show more of the same i.e. current
account surpluses. The month printed a current account surplus of USD1019 mn,
bringing the 2010 YTD surplus to USD12.8bn vs. the same period in 2009 of USD18.6bn
or down about 30.8%. The year of the rabbit is likely to see smaller surpluses whereby
KResearch has penciled in about USD 8.3bn to 11.7bn. Given that this will be an election
year, chances are rising that domestic demand (the sum of consumption, private sector
spending a.k.a. investments and government spending) can fall on the way side which
means imports would decelerate. Once a house dissolution is announced, the
government becomes a care taker government which equates to lackluster spending.
Post the elections, the political jockeying for key ministerial and cabinet posts are hotly
contested, especially in a coalition government. And if history is any guide, coalition
governments are hardly stable, which will be reflected in both policies and their
implementations i.e. from the sales of dreams to tangible reality. Need a reminder? How
long did it take for Thailand to get its new airport, sky-train, underground mass transit
system. We are still eagerly awaiting a formal 3G telecommunication system whereas
other countries are already heading towards 4G.
Taking this into consideration, it could be a period of one to two quarters before the
political dust settles between the death and rebirth of a new government. In such
uncertain circumstances, the private sector is likely to shift its investment gear to “neutral”
until the political roadmap is clearer. This again reiterates a low import environment. As
such, fig 7 and 8 show the implications for USD/THB as exporters outnumber importers.
Hint…higher current account surpluses generally mean lower USD/THB levels.
Fig 8. …sliced in another way…cumulative current
Fig 7. Yes, the current account does matter
account vs. USD/THB
USD/THB
40,000 29 48
30,000 31 46
33 44
20,000
35 y = -0.0003x + 37.339
10,000 42 2
37 40 R = 0.7158
0 39
38
-10,000 41
36 latest data point
-20,000 43
34
45
-30,000 32
01 02 03 04 05 06 07 08 09 10 30 34455, 30.2
28
TH current account cumulative, Jan 91 = base, USD mn, left axis -30,000 -20,000 -10,000 0 10,000 20,000 30,000 40,000
USD/THB, right axis, inverted cumulative current account balance, Jan 91 = base, USD mn
Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank
Portfolio flows are unlikely to incur material changes as the West is still looking into the
face of deflation rather than inflation. The US Treasury Inflation Protection Securities or
TIPS market might say different as the spread between the yield of the regular issues
and TIPS issues widens. While one might argue that the rise in yields is due to fears of a
blow out budget deficit, this probably is not the case since, it would require that both the
yields on both types of securities to rise in tandem and hence keep the spreads relatively
constant. But we view that the deck remains stacked against higher inflation expectations
since there are still 15 million Americans out of work. The most recent minutes of the
December 14th FOMC (Federal Open Market Committee) suggests caution is warranted:
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5. In their discussion of the economic situation and outlook, meeting participants
saw the information received during the intermeeting period as pointing to some
improvement in the near-term outlook, and they expected that economic growth,
which had been moderate, would pick up somewhat going forward. Indicators of
production and household spending had strengthened, and the tone of the labor
market was a little better on balance. The new fiscal package was generally
expected to support the pace of recovery next year. However, a number of
factors were seen as likely to continue restraining growth, including the
depressed housing market, employers' continued reluctance to add to
payrolls, and ongoing efforts by some households and businesses to
delever. Moreover, the recovery remained subject to some downside risks,
such as the possibility of a more extended period of weak activity and
lower prices in the housing sector and potential financial and economic
spillovers if the banking and sovereign debt problems in Europe were to
worsen. In light of recent readings on consumer inflation, participants noted that
underlying inflation had continued trending downward, but several saw the risk of
deflation as having receded somewhat.
Fig 9. Yields on 5yr UST less 5yr TIPS Fig 10. …but there is 15 million Americans out of work
18000
%
16000
3.0
2.5 higher inflation 14000
2.0 12000
1.5 10000
1.0 8000
0.5 6000
0.0 4000
-0.5 lower inflation 2000
-1.0 0
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 48 51 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08
5yr UST - TIPS unemployed, k
Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank
So, the message is that the US and much of the Western world will be careful before
even contemplating cutting back on quantitative easing (QE). On the other side of the
world, Asia is trying to undo the West’s quantitative easing by quantitative tightening (QT)
for fear that easy money will reduce the quality of growth and result in economic cancer
or asset bubbles. China is feverishly working to keep its inflation genie in the bottle, but
that might be too late since there comes a point where the pursuit of growth will lead to
inflation unless productivity gains are made. So, China has again executed more QT, by
jacking the reserve requirement a 50bps further in hope for slowing money circulation
and too much money chasing too few goods. While in Thailand, the central bank stepped
up FX intervention in an endeavor to break the trend whereby the increase in foreign
investors’ position in Thai fixed income leads to lower USD/THB level in a linear fashion.
But will Thai authorities get tougher? Election year politics should discourage the
government from prescribing tough medicine against the spread of the QE virus with
harsh capital controls. The capital markets, primarily the stock market is one of the best
money making machines to finance political campaigns.
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6. Fig 11. China’s reserve requirements Fig 12. Foreign positions in Thai fixed income
USD/THB
20
33.5
18
33.0
16
14 32.5
12 32.0 y = -0.0175x + 32.746
10 31.5 2
R = 0.9143
8 31.0
6 30.5
4 30.0 215, 30.06
2 29.5
0 29.0 stepped up FX intervention to break the trend
00 01 02 03 04 05 06 07 08 09 10 11 28.5
-50 0 50 100 150 200 250
major banks small banks 2010 - 11 foreign position in Thai fixed income
Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank
Given the dichotomy of growth between the West and Asia, money will continue to flow to
places where the risk / reward ratio is most optimal. The market’s mind is still leaning
towards lower USD/CNY 12 mth down the road by about 2.74%. As long as China
continues to postpone a more liberal FX regime, regional currencies will remain the
recipients of residual flows. We hold onto our 4Q11 USD/THB target of 28.00.
Fig 13. USD/CNY 12mth NDF Fig 14. KBank USD/THB model
USD/CNY NDF curve KBank USD/THB model
6.90 48
46
6.80 44
42
6.70 40
38
6.60
36
6.50 34
32
6.40 30
mths forward 28
6.30
01 02 03 04 05 06 07 08 09 10 11 12
0 1 2 3 4 5 6 7 8 9 10 11 12
06/01/11 1mth ago 3mth ago 6mth ago 1yr ago actual model
Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank
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7. Continued current account surpluses: good for the Thai baht, bad for
the Thai citizens
The current account surplus is a main pillar of our call for the USD/THB. But what needs
to be discussed is that it is a negative indicator of a severe imbalance between the
external and internal economy. While it is a good sign for the Thai baht, it might be bad
for the Thai citizens, primarily present and future taxpayers. Economists have an alias for
the current account balance, that is, the investment / savings gap. The higher the current
account surplus, the more Thailand is saving than investing. Pre 1997, it was the reverse
position whereby the current account was in deficit as Thailand was investing (rather
squandering) than saving. Today’s situation is symptomatic of either lack of confidence,
lack of a national strategy, political instability, antiquated tax regimes…or all of the
previous.
Fig 15. Current account & outstanding public debt Fig 16. BOT FX reserves & bonds outstanding
80,000 4,500 2400 170
excessive diesel subsidies led to 2200 160
70,000 4,250 150
both a budget and current 2000 140
60,000 4,000 1800
account deficit 130
50,000 3,750 1600 ρ = 97% 120
1400 110
40,000 3,500 100
ρ = 94% 1200 90
30,000 3,250 1000 80
20,000 3,000 800 70
10,000 2,750 600 60
400 50
0 2,500 40
200 30
00 01 02 03 04 05 06 07 08 09 10 0 20
01 02 03 04 05 06 07 08 09 10
cumulative current account, USD mn, April 2000 is base, left axis
outstanding public debt,THB bn, right axis BOT Bonds O/S (left axis) FX reserves (right axis)
Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank
This is then reflected in weak imports. In a futile endeavor to breathe life into the local
economy, fiscal expansionary policy becomes more aggressive, equating to more
borrowings from the future tax revenues to fund the short fall from the present income
and hence rising public debt. Fig 15 clearly shows that between Sept 2006, whereby the
coup marked the start of Thailand political and social struggle, to today, the amount of
public debt had risen from THB 3.2 trillion to THB 4.2 trillion. To our understanding, this
amount of public debt excludes debt issued by the central bank. But as history has
shown, the central bank’s debt can become the public debt and serves as a reminder that
the pain of 1997 has not disappear as many would like to believe. The losses incurred
from preventing the collapse of Thailand’s financial system resulting in loss by the
Financial Institution Development Fund (FIDF) was initially THB 1.4 trillion. Today, that
FIDF debt was fiscalized about a decade ago, but the outstanding is still about THB 1.1
trillion (please see http://www.pdmo.mof.go.th/?q=th/jakkdownload/138 for more details).
No matter how these figures are spun i.e. as a percent of GDP it is still low…about 42%,
the absolute levels in fig 15 tells us that political will is lacking as authorities are reluctant
to pay it down since it would be politically unpopular as seen in European nations
undergoing austerity measure e.g. strikes in Greece, France, Ireland, Portugal.
The next worry on the wall is fig 16. While the outstanding BOT bonds are not included
yet in public debt, the trend is worrisome. As part of FX intervention and sterilization, a
positive balance of payments requires that the central bank buys USD/THB funded by the
issuance of BOT bonds. The USD bought are then recycled to “perceived to be safe”
investments such as US Treasuries and bonds of the Eurozone nations. The likes of
Greece and other peripheral EU sovereigns have already seen a barrage of downgrades,
a collapse in prices and a rise in yields. Investments in these assets have revealed their
flaws since they are denominated in currencies which the baht has been appreciating
against, leading to both realized and unrealized translation losses. The credit downgrade
story has partly been played but the main attraction has not…the impending fear of a US
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8. credit downgrade from its AAA credit rating. This was the highlight of PIMCO founder / co
–CIO, William Gross’s recent piece…”Off With Our Heads” which made these key points:
American politicians and citizens alike have no clear vision of the costs of a
seemingly perpetual trillion-dollar annual deficit.
Policy stimulus is focused on maintaining current consumption as opposed to making
the United States more competitive in the global marketplace.
Dollar depreciation will sap the purchasing power of U.S. consumers, as well as the
global valuation of dollar denominated assets.
So while on a US dollar bill, the words “In God we trust” is printed, the question for Asian
central bankers need to ask is : “In the US dollar we trust”?
Fig 17. Breakdown of foreign holdings in UST Fig 18. US credit default swaps
65
UST holdings Japan 60
20.4%
55
Others 50
36.6% 45
40
China 35
21.0% 30
25
Thailand 20
1.5% Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11
OPEC
UK
5.0% Germany Taiwan
11.1% US credit default swaps, bps
1.4% 3.0%
Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank
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9. Fig 19. Monthly Key Economic Indicators May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Nov 10 Dec 10
Manufacturing index 185.0 194.2 190.1 183.7 201.5 191.2 190.4
% YoY 15.9 14.2 13.1 8.4 8.1 6.0 5.6
Industrial capacity utilization rate (%) 64.3 65.4 64.8 63.6 64.4 63.9 63.6
Retail sales (% YoY) 8.1 11.9 12.3 8.5 8.9 4.7 4.7
Passenger car sales (units) 62,205 70,557 65,672 65,724 68,261 72,012 78,874
Motorcycle sales (units) 138,558 168,389 175,926 153,256 147,932 145,916 154,971
Unemployed labor force ('000 persons) 586 459 346 353 343 355
Commercial car sales (units) 1.5 1.2 0.9 0.9 0.9 0.9
Consumer prices (% YoY) 3.5 3.3 3.4 3.3 3.0 2.8 2.8 3.0
core 1.2 1.1 1.2 1.2 1.1 1.1 1.1 1.4
Producer prices (% YoY) 8.0 11.5 11.1 10.7 9.1 6.3 5.9 6.7
External Accounts (USD mn, unless specified otherwise)
Exports 16,435.0 17,877.0 15,475.0 16,292.0 17,955.0 17,046.0 17,584.0
% YoY 42.5 47.1 21.2 23.6 21.8 16.6 28.7
Imports 14,144.0 15,334.0 16,266.0 15,440.0 14,712.0 14,773.0 17,094.0
% YoY 53.6 38.3 36.5 41.8 15.7 14.4 35.0
Trade balance 2,291.0 2,543.0 -791.0 852.0 3,243.0 2,273.0 490.0
Tourist arrivals ('000) 815 953 1,258 1,268 1,220 1,360 1,500
% YoY -11.8 -0.2 14.7 12.5 1.9 6.3 10.3
Current account balance 1,172.0 821.0 -1,001.0 280.0 2,767.0 2,740.0 1,019.0
Balance of payments -989 2,166 1,412 3,589 4,270 5,822 820
FX reserves (USD bn) 143.4 147.1 151.5 154.7 163.1 171.1 168.2
Forward position (USD bn) 13.0 12.2 11.0 12.1 11.1 12.6 15.3
Monetary conditions (THB bn, unless specified otherwise)
M1 1,261.9 1,180.2 1,173.0 1,181.4 1,175.5 1,202.3 1,235.4
% YoY 14.4 15.1 15.8 11.4 11.7 11.4 10.8
M2 11,001.5 10,846.4 10,887.1 10,968.1 11,116.1 11,322.4 11,497.3
% YoY 6.7 6.9 8.7 8.4 9.8 11.1 11.0
Bank deposits 10,229.1 9,983.3 9,974.5 10,015.9 10,091.6 10,204.1 10,389.3
% YoY 7.0 6.2 7.6 6.6 7.8 8.5 8.1
Bank loans 9,101.2 9,196.7 9,219.7 9,299.8 9,432.7 9,580.5 9,743.9
% YoY 7.3 8.5 9.1 9.8 10.8 12.1 12.2
Interest rates (% month end)
BOT 1 day repo (target) 1.25 1.25 1.50 1.75 1.75 1.75 1.75 2.00
Average large banks' minimum lending rate 5.86 5.86 6.00 6.00 6.00 6.00 6.00 6.12
Average large banks' 1 year deposit rate 0.68 0.68 0.98 0.98 1.11 1.11 1.11 1.32
Govt bond yield 1yr 1.52 1.56 1.91 1.99 2.01 1.98 2.11 2.38
Govt bond yield 5yr 3.06 2.99 3.08 2.69 2.56 2.83 2.98 3.26
Govt bond yield 10yr 3.49 3.33 3.44 3.01 3.12 3.18 3.59 3.77
Key FX (month end)
DXY US dollar index 86.59 86.02 81.54 83.20 78.72 77.27 81.20 79.03
USD/THB 32.51 32.42 32.26 31.27 30.33 29.91 30.20 30.06
JPY/THB 35.67 36.61 37.31 37.18 36.35 37.16 36.11 37.02
EUR/THB 39.96 39.79 42.12 39.73 41.31 41.62 39.37 40.18
Source: Bloomberg
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10. 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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