1. .Mean S Multi Asset Strategies
KBank Strategies
Macro / Multi Asset
Not such a Happy New Year after all January 2011
Volume 44
Holiday mood hangover had been putting a positive spin on
sentiment for the time being
Kobsidthi Silpachai, CFA –Kasikornbank
Bullish ADP reading suggest Friday’s non-farm payrolls added kobsidthi.s@kasikornbank.com
more fuel to the optimism…only to be disappointed by the figure Susheel Narula – KSecurities
from the Bureau of Labor Statistics showing that non-farm susheel.n@kasikornsecurities.com
payrolls fell short of expectations Kavee Chukitkasem – KSecurities
kavee.c@kasikornsecurities.com
Hence the US will keep QE while Asia goes QT, that is
quantitative tightening KResearch
kr.bd@kasikornresearch.com
Election year syndrome reinforces the sustained probability of
current account surpluses and hence we retain our 4Q11
USD/THB target of 28.00
Disclaimer: This report
We have become more bullish this month and abandoned our must be read with the
earlier view for investors to reduce their portfolio. We now Disclaimer on page 41
that forms part of it
expect the SET index to hit 1220 during the first half of the year
instead of the second half. The downside risk of the SET index is
not expected to be lower than 980 in the short-term
Strategic Thesis “KBank Multi Asset
The New Year is a period of high hopes. It looked like things were really getting better in Strategies”
the world’s largest economy as manufacturing data was on the up and up. To get the can now be accessed on
economists and markets even more exuberant, jobs data from ADP gave a surprising Bloomberg: KBCM <GO>
tease, well exceeding expectations. Unfortunately, the optimism faded when the Bureau
of Labor Statistics told their sad story. Non-farm payrolls remained weak, while investors
were trying to make heads or tails about the declining unemployment rate from 9.8% to
9.4%. The decline was for the wrong reasons as it turned out, since the labor force was
declining, attributed to discourage job seekers. The immediate read from Asia was
negative, possibly on concerns of stagflation…a combination of decelerating growth and
accelerating inflation. This will gave the US dollar a temporary boost for its safe haven’s
sakes…but how long. Inflation risk for the West will still be to the downside. Fed
Chairman – Ben Bernanke reiterated that it could take 4-5 years before the US job
market normalizes and hence suggests to us that it would the considerable same
amount of time before US monetary policy also normalizes. So there will be more need
for paper and green ink to print more US dollars. Local catalysts for USD/THB remain
the current account surpluses. The year of the rabbit is likely to see smaller surpluses
whereby KResearch has penciled in about USD 8.3bn to 11.3bn. Given that this will be
an election year, chances are rising that domestic demand can fall on the way side
which means imports would decelerate. We hold onto our 4Q11 USD/THB target of
28.00 given these considerations. On equities, we have become more bullish this month
and abandoned our earlier view for investors to reduce their portfolio. We now expect
the SET index to hit 1220 during the first half of the year instead of the second half. The
downside risk of the SET index is not expected to be lower than 980 in the short-term.
11
1 WWW.KASIKORNBANKGROUP.COM
7. Not such a Happy New Year after all
Kobsidthi Silpachai, CFA - Kasikornbank
Holiday mood hangover had been putting a positive spin on kobsidthi.s@kasikornbank.com
sentiment for the time being
Warunee Sithithaworn – Kasikornbank
Bullish ADP reading suggest Friday’s non-farm payrolls added more warunee.si@kasikornbank.com
fuel to the optimism Nalin Chutchotitham – Kasikornbank
nalin.c@kasikornbank.com
…only to be disappointed by the figure from the Bureau of Labor
Statistics showing that non-farm payrolls fell short of expectations
Right for the wrong reasons: US unemployment eased from 9.8% to
9.4% but the labor force reduced as job seekers are discouraged
Based on the Taylor rule, low inflation and high unemployment
means that the Fed Funds rate should be a negative 2.2% under the
assertion that the central bank has only one monetary tool
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
surpluses is good for the Thai baht, but it is not good for the Thai
citizen
Sufficient liquidity in the hands of investors to absorb the new
bonds in the remaining three quarters of FY2011
Inflation rates would climb gradually but the market has yet to fully
price in price pressure from higher world commodity prices
BoT’s forecast shows more of price risks lie in the year 2011 than
in 2012 – slowdown in 2012 and completion of policy rate hikes are
likely to result in milder core inflation rate next year
Given substantial uncertainties to the pace of the US recovery and
differing views in the market, US treasuries are to continue seeing
substantial fluctuations throughout the year 2011
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8. Fig 1. The wild ride for US jobs ….and recovery in 2011
Source: Cagle.com
The irrational exuberant optimism from the New Year festivities?
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 (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 mean 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
88
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9. 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 have been about
323k.
Fig 4. ADP & BLS non-farm payrolls mapping Fig 5. KBank DXY model
latest data point mapping
600 90
88
y = 1.0184x + 16.132 86
2
400
R = 0.8819 84
200 82
ADP employment change, k 297, 103
0 80
78
-1000 -800 -600 -400 -200 0
-200 200 400 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
Release of Jobs Friday (first Friday of each month) sees the BLS highly influential data
non-farm payrolls as well as the unemployment, which confounded the markets again.
The BLS non-farm payrolls posted on 103k against expectations of 150k while the
unemployment rate eased from 9.8% to 9.4%. Data snorkeling (i.e. looking into the water
from only the surface) might show a pretty nice view as the unemployment rate fell. Data
diving with scuba tanks (for more in-depth analysis) shows the reason why the
unemployment rate fell. In the unemployment rate, the numerator is the number of total
number of people actively looking for work but can not find work. The denominator is the
size of the total labor force, the sum of those who are currently working and those who
are not. The reason for a fall in the ratio can be due to:
the numerator reduced while the denominator was unchanged
the denominator increased while the numerator was unchanged
the numerator reduced while the denominator increased
…or the numerator reduce while the denominator declined but at a slower rate than
the numerator
The last appears to be the case. In December, the number of unemployed workers fell by
556k or 4% against the prior month, while the total labor force also declined but at a
slower rate of 3.5% or 259k against the prior month. The move in the direction of the
unemployment rate appears positive, but it is for the wrong reasons. A decline in the total
labor force is symptomatic that the labor force has given up hope.
In Ben Bernanke’s recent testimony to Congress, he expressed concerns that the longer
people are out of work, their skills become more obsolete, which makes it even more
difficult to return back to the labor force. This is like the saying, “Use it or lose it”. Imagine
a person going for a job interview and that person’s CV has been idle for the past two
years. It becomes a stigma and suspected attestation that the person is not in demand by
the jobs market.
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10. The other issue that looks to hold back the consumption variable (and Asia’s exports) in
the US economy is that, given the large slack in the labor market, the balance of power is
with the employer rather than the existing employee, which means that negotiating power
for wage increases is very weak. To substantiate this case, fig 6 shows the relationship
between the level of non-farm payrolls and the non-farm payrolls cost index (the
employer’s cost is the proxy for the employee’s revenue, wages). Rising non-farm
payrolls is reflective of a recovering jobs market and tips the scale for higher non-farm
cost, which means higher wages. Higher wages means higher consumption. But if the
case is not this i.e. weak non-farm payrolls weak non-farm payroll cost weak wages
low consumption low demand side inflation. To further add to the pessimism, the
US labor participation rate has been consistently declining, fig 7. The participation rate is
the percentage of the general population that is in the labor force. Such a trend seems
more structural than cyclical, possibly reflective of the rise in the aging population as the
baby boomers enter retirement.
Fig 6. non-farm payrolls & non-farm cost index Fig 7. US labor participation rate
nonfarm cost index
120 68
y = 0.001x - 34.097 67
100 2
R = 0.9701 66
80 65
64
60 63
62
40 61
60
20 59
58
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
40,000 60,000 80,000 100,000 120,000 140,000
nonfarm payrolls, k participation rate, % of total US population
Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank
It seems that for the time being, the markets’ bias is for US dollar upside for either good
or bad data. Prior to this release, dollar bulls were arguing that the Fed might not spend
all of Quantitative Easing part 2.0 program of USD 600bn citing improved economic
conditions. Following the non-farm payrolls disappointment, the US dollar continues to
benefit from the risk aversion. A slower growing than expected US economy can only be
bad news for Asia coupled with inflation to stagflation fears for the region, investors are
opting to take some money off the table.
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, 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?
1010
10
11. Fig 8. 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 2.2% based on a 0.80% core PCE
(proxy for inflation) and unemployment of 9.4% (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%.
1111
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12. 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 11.3bn. 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 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 9 and 10 show the implications for USD/THB as exporters outnumber importers.
Hint…higher current account surpluses generally mean lower USD/THB levels.
Fig 10. …sliced in another way…cumulative current
Fig 9. 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:
1212
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13. 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 11. Yields on 5yr UST less 5yr TIPS Fig 12. …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 are one of the best
money making machines to finance political campaigns.
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14. Fig 13. China’s reserve requirements Fig 14. Foreign positions in Thai fixed income
USD/THB
20
34.0
18
16 33.0
14
12 32.0 y = -0.0158x + 32.678
10 2
R = 0.8631
8 31.0
6 259, 30.37
30.0
4
2 29.0
0 stepped up FX intervention to break the trend
00 01 02 03 04 05 06 07 08 09 10 11 28.0
-50 0 50 100 150 200 250 300
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 months down the road by about 2.58%. 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 15. USD/CNY 12mth NDF Fig 16. 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
10/01/2011 1mth ago 3mth ago 6mth ago 1yr ago actual model
Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank
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15. 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 17. Current account & outstanding public debt Fig 18. 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 17 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 disappeared 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 17 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 measures e.g. strikes in Greece, France, Ireland, Portugal.
The next worry on the wall is fig 18. 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
1515
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16. 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
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 19. Breakdown of foreign holdings in UST Fig 20. 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
Fig 21. Thailand's balance of payments
USD mn Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10
BoP: Exports fob 17,876.5 15,475.1 16,291.6 17,954.9 17,045.5 17,584.0
BoP: Imports cif -15,334.2 -16,266.3 -15,439.8 -14,712.2 -14,772.9 -17,093.8
BoP: Trade Balance 2,542.4 -791.3 851.7 3,242.7 2,272.7 490.2
BoP: Current Account Balance 820.9 -1,000.8 280.5 2,767.0 2,739.6 1,019.0
BoP: Capital and Financial Account Balance 741.2 2,979.8 3,205.9 1,125.8 2,404.6 n.a.
BoP: Overall Balance 2,166.4 1,412.2 3,589.4 4,269.8 5,821.7 820.3
FX Reserves 146,759.2 151,524.7 155,186.8 163,235.3 171,061.6 167,973.9
Change in FX Reserves 3,240.6 4,765.5 3,662.1 8,048.5 7,826.3 -3,087.7
Estimated intervention 1,074.2 3,353.3 72.7 3,778.7 2,004.6 -3,908.0
Source: Bloomberg, CEIC, KBank
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17. Ongoing inflationary concerns and unfinished rate hikes
Sufficient liquidity in the hands of investors to absorb the new
bonds in the remaining three quarters of FY2011
Inflation rates are expected to climb gradually but the danger is
that the market has yet to fully price in price pressure from higher
world commodity prices
BoT’s forecast shows more of price risks lie in the year 2011 than
in 2012 – slowdown in 2012 and completion of policy rate hikes are
likely to result in milder core inflation rate next year
Given substantial uncertainties to the pace of the U.S. recovery and
differing views in the market, U.S. treasuries are to continue seeing
substantial fluctuations throughout the year 2011
Local bond market update
Supply news from year-end – The Public Debt Management Office (PDMO) released
its bond auction plan for the January-March 2011 period (Q2 of fiscal year 2011) towards
the end of December 2010. The table below summarizes the key changes to the tentative
plan announced back in September.
In general, we expect that there would be sufficient liquidity in the hands of investors to
absorb the new bonds in the remaining three quarters of FY2011. This is especially so as
Bt160bn of government bonds mature during the course of the year, indicating a net
issuance for FY2011 of about Bt290bn. Hence, the supply side factors are unlikely to be
an issue for the bond market.
Issuance framework for Q2/FY2011 Coming up in the next few months
Total supply for Q2 is Bt94.5bn (Bt90bn in Q1) Authorities said to expect new inflation-linked bonds in
May
Introduction of Bt3.5bn of the new 50-year bond issue.
Savings bonds of tenor 7-12 year may be added to bond
No auctions of T-bills for two months. There’s ample issuance of FY2011 (expected in April). Total size may be
government’s treasury cash (around Bt250bn at end Dec). t100bn. Coupon may be fixed rate or step-up
Auction size of 5-10 year bonds reduced to Bt10bn from Changes to Primary Dealers’ roles (PDs) as part of
last year’s Bt12.5bn. ongoing development of the bond market
Auction size of 30-year bonds is raised from Bt3bn to
Bt5bn
Bt40bn of 12- and 18-year fixed-rate P/N to supplement
bond issuance for long-term investors e.g. insurance
companies and pension funds
Source: PMDO, KBank
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18. Fig 22.Preference over mid-curve bonds in recent trade Fig 23. Changes to bond supply Q1 vs. Q2
bps Mid-curve government bond yield spread Bt bn
80 30
70 25
60
20
50
15
40
30 10
20 5
10
0
0
5Y 7Y 10Y 12Y 15Y 20Y 30Y 50Y 4Y FRN CPI
May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11
linked
LB155A - LB196A spread LB133A - LB155A spread Q1 Q2 Tenor/type
Source: Bloomberg, KBank Source: PDMO, KBank
Fig 24. Preference over mid-curve bonds in recent trade Fig 25. Government bond and IRS yields change
bp Yield change before and after Dec 1st rate hike
Maturing Government loan bonds
bn baht 80
100 89 70
88
80 60
70
50
60 40
40
40 30
20
20
3 10
0
0 0
Q4/2010 Q1/2011 Q2/2011 Q3/2011 Q4/2011 Q1/2012 0.3 0.5 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 15.0 20.0
tenor (yrs)
Principal IRS change Bond change
Source: , Bloomberg, KBank Source: PDMO, KBank
Early reaction to the bond supply – Notice below that the amount of 5-year bonds
lessened by about half while those of the 7- and 10-year bonds had increased. Overall,
the changes in both quarters’ supply are not significant. However, we feel that the
demand for 5-year bonds should remain strong among investors – it is neither too short
nor too long and it remains one of the more liquid issues. Hence, since end-Dec, we had
been seeing a strong preference for the mid-curve tenor – observe how yield spread
widened between the 5- and 9-year issues and declined between the 2- and 5-year
issues. This trend had recently slowed as investors thought there are limits to gains in the
5-year.
The more important factors for this year are the inflationary trends and policy rate actions.
Inflation rates are expected to climb gradually but the danger is that the market has yet to
fully price in price pressure from higher world commodity prices. As for policy rate hikes
that are lined up at the Bank of Thailand’s (BoT), we think they could be announced as
soon as January 12th. Based on BoT’s inflation rates forecast, more of price risks lie in
the year 2011 than in 2012. The slowdown in economic activities in the year 2012 and
completion of policy rate hikes this year are likely to result in milder core inflation rate
increased next year. At the same time, global liquidity is likely to start reducing into the
year 2012. In short, we expect the BoT to react in a pre-emptive way by raising the policy
rate three times during the first three meetings of the year (January, March, April).
However, we do expect each hike to be 25 bp, due to the concerns for capital inflows and
substantial liquidity in the local market. Currently, the market is pricing a bear-flattening
trend of the sovereign yield curve going forward.
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19. Fig 26. Implied forward sovereign yield curves Fig 27. 6mx6m forward change
% bp %
Implied bond yield curve shifts
4.50 120
4.00 100
3.50 80
60
3.00
40
2.50
20
2.00
0
1.50 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Jan-11 Apr-11 Jul-11 Jan-12 tenor (yrs) 6m6m bond change 6m6m IRS change
Source: Bloomberg, KBank Source: Bloomberg, KBank
We think that there would be plenty of reasons for inflation to continue rising this year.
The sources of price pressure are several, from the demand side of supply side. From
the supply side, commodity prices remained on an uptrend, especially after the year 2010
saw a number of occasions of severe weather. At the same time, the NYMEX WTI crude
oil price futures curve is also seeing a parallel shift upwards from three months ago.
Although the curve is not very steep, given that uncertainties to global growth remain, the
shifting of the curve does indicate that the market is more convinced that oil prices would
maintain its higher trend from here. From the demand side, we expect the up trend in
private consumption and investment to continue, helping to close the output gap in the
economy i.e. absorbing some of the excess capacity.
In light of all of the development in the medium term, we continue to prefer bonds in the
belly of the curve and recommend investors to reduce duration. However, the BoT’s
latest economic forecast due for releases at end January would be a key factor in the
determination of future policy rate hikes as well.
Fig 28. Crude oil (NYMEX WTI) futures curves Fig 29.CRB index vs. Thai producer price index
$/barrel
500 190
94 CRB Index ( Reuters/Jefferies world commodities index)
450
92 Thai producer price index, PPI (right axis) 170
400
90
150
350
88
300 130
86
250
84 110
200
82
90
150
80
1 2 3 4 5 6 7 8 9 10 11 12 100 70
WTI futures current 1M ago 3M ago 12M ago 98 99 00 01 02 03 04 05 06 07 08 09 10
Source: Bloomberg, KBank Source: Bloomberg, KBank
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20. Argument for <=50bp rate hike in 2011 Argument for > 50bp rate hike in 2011
Although global economic recovery is likely to As a rule, interest rate pass through is slow in creating
continue, the pace at which this happens would be a real impact on the economy
more gradual as compared to that observed in 2010
Prevention of expectation of higher inflation taking its
BoT have started to normalize interest since July last own course
year. Impact from its early move is likely to be felt in
H1/2011 Interest rates still do not reflect the costs of capital –
monetary policy stance remained loose
Domestic demand is on an up trend but the pace of its
acceleration is not threatening There are several risk factors which are out of
BoT/MOF’s control e.g. severe weather impact on
Too fast + too much interest rate increase may induce global commodity prices (supply side), energy prices
speculative capital inflows
Early prevention of any form of asset bubble building
Increased costs of liquidity absorption and FX up – the stock market and the bond market had been
sterilization of BoT driven by liquidity during the past year
Update on U.S. Treasury - yields may see a roller-coaster ride for
another year
For the past one month, the U.S. treasury yields had risen substantially, led by the
optimism of the market with regards to positive economic data coming out from both the
U.S. and other parts of the world. A revisit to the implied expectation concerning the Fed
fund rate, the market still expects no change in the Fed’s target policy rate until the year
ends. However, the change in the market’s sentiment with regards to the continued
recovery in the U.S. economy had led to sell-off in the bond market, sustained rising of
the major U.S. stock indices, and even some early short-cover of the U.S. dollar.
Nevertheless, if we take a look at the market’s forecast of the 2- and 10-year U.S.
treasury yields for the next four quarters, we would find that there are substantial
differences between different houses’ views. Yet, this observation should not be a
surprise as well. There remain arguments concerning the impacts of government
borrowing and QE 2.0 on U.S. economic recovery and the inflationary pressure going
forward. While economic recovery remained weak and unemployment situation helps to
keep inflation under control, the corporate sector had seen better improvement and the
liquidity that bolstered increase in stock prices might stoke asset price bubbles and
inflationary pressure.
Given substantial uncertainties to the pace of the U.S. recovery and the impacts of
government’s policies, coupled with differing views in the market, we expect the U.S.
treasury to continue seeing substantial fluctuations throughout the year 2011. The recent
optimism in the stock market led the 2-10 spread to increase to about 273bp, nearing
February 2010’s high of 291 bp. We think that there would definitely be corrections
ahead, especially as the Federal Reserve still has about 6 more months to go for its QE
2.0 program.
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