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Published on March 12, 2008

Thai two-year yields fell from 3.201 per cent as of February 27 to current levels of 2.956 per cent as the local market was hopeful for the return of foreign investors who had largely exited following the imposition of the reserve requirement. 

Prior to the capital controls, foreign holdings in Thai fixed income had peaked at Bt112.8 billion but, following the controls, continually fell to a low of Bt46.9 billion. Data as of March 7 showed an increased exposure by offshore investors to the tune of Bt57.16 billion against the prior week's Bt53.85 billion.

Going forward, catalysts likely to con-tinue putting bonds in favour for the short-term include the March 18 Federal Open Market Committee. Interest-rate futures are pricing in that the Bernanke Fed will opt for an aggressive 75 basis point cut from 3 per cent to 2.25 per cent, in order to avert the risk of the US economy heading into recession.

Falling Fed Funds would mean that Libor would take a similar path as well as Thailand's synthetic cost of borrowing US dollars - THBFIX. THBFIX represents borrowing US dollars at Libor but at the same time eliminates foreign exchange risk through the use of FX swaps. Easing THBFIX subsequently influences other interest rates securities such as interest rate swaps and Thai government bonds in a positive manner.

For the longer term, risks to the Thai fixed income are accelerating inflation and increased threat of new government bond supply. No doubt, crude-oil futures hitting recent highs of US$108 (Bt3,400) suggest that cost push inflation pressure is something very formidable for policy makers to tackle.

This is could begin to erase market expectations of a cut by the Bank of Thailand, as it had hinted that headline inflation was expected to be moderate going forward. On the other hand, the pursuance of populist policies implies that government cash requirements will increase, expanding the budget deficit and hence the issuance of more government bonds.