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Published on April 22, 2008

Thiti Tantikulanan is head of capital markets at Kasikornbank

With the prospects of higher food and oil prices putting upward pressure on core inflation and inflation expectations, traders and investors are beginning to reassess that the Federal Open Market Committee (FOMC) may be nearing a pause in its interest-rate easing cycle after the fastest reductions in two decades.

Since the previous FOMC meeting last month, US federal funds futures have been pricing in a 0.5-per-cent cut at the next FOMC meeting on April 30. Last week, the market shifted views with Fed Funds futures now pricing in only a 0.25 per cent cut while the two-year US treasury notes posted its biggest weekly yield surge since 2001, climbing from 1.75 per cent to 2.10 per cent. This is not to say the financial crisis in the US economy is over - far from it. What the markets are forecasting is the Federal Reserve will not be able lower the interest rate much from here. If it does, it risks inflating the economy out of the crisis and in the process creating another threat.

Closer to home, two Asian countries are noticeably concerned about inflation. Last month, the South Korean prime minister assured the investment community he would be vigilant about inflation taking precedence over growth. Then two weeks ago, the Singaporean central bank, the Monetary Authority of Singapore (MAS), surprised the market by raising the trading band of the Singaporean dollar. This effectively signalled their worries regarding inflation and that the Singaporean dollar would be allowed to appreciate at a faster pace, in order to curtail some of that inflation.

At home, the Thai capital market has been pricing in at least a 0.5-per-cent cut from the central bank's Monetary Policy Committee since the beginning of the year. The rationale is the economy needs a boost and to close the gap between the US and Thai interest rates, currently 1 per cent. Such a gap may be deemed too wide and cause unwanted speculative capital inflow. However, since the lifting of the 30-per-cent capital controls, the baht has been trading in a relatively stable range of 31.15-31.80 to the US dollar, albeit with some help from the Bank of Thailand's intervention and a deceleration in the decline of the US dollar against most world currencies.

The interest-rate market reversed some of its bets about local rate cuts last week, which saw two-year interest rate swaps, equivalent to two-year interbank rates, jump from 3.13 per cent to 3.46 per cent, while two-year bond yields climbed 3.16 per cent to 3.25 per cent.

With the export sector contributing 60 per cent to Thai gross domestic product, it is hard to think the authorities will use an MAS-style policy to curtail inflation. Therefore, maintaining the policy interest rate at the current level may be necessary. Thus, do not be surprised to see further upward correction to the rates in the Thai capital market.