Bonds stay bearish as inflation firms

This reading has proven correct so far, with the central bank keeping its one-day repo rate on hold at 3.25 per cent at the April 9 Monetary Policy Committee meeting.

It also revised up its 2008 headline and core inflation forecasts to 4 to 5 per cent and 1.5 to 2.5 per cent in its quarterly inflation report. This, coupled with optimism for fiscal stimulation policies, prompted a round of revisions by analysts for the Bank of Thailand's monetary policy expectations, with some now even calling for hikes by the end of the year.

However, the bearish market was offered some reprieve early this month with the emergence of sizeable offshore inflows into the belly and long end of the yield curve.

Talk is that the upward reweighting of Thailand in a global bond index on May 1 ignited this offshore interest, although we remain sceptical that it was purely index-driven, with many other possible explanations at hand.

For instance, local bond yields recovered by 70 to 100 basis points from their troughs at the belly and long-end of the curve, which could have made bonds here attractive to some total return funds.

Benchmark funds could also have easily traded off-benchmark and added Thai bond exposure at any time, if they saw value in the Thai curve, regardless of index changes.

In either case -index driven or not - we do not expect this flow to be sustained with the focus likely to soon shift back to fundamentals.

We have revised our Bank of Thailand policy rate outlook and now expect the central bank to cut its one-day repo rate by 25 basis points in the fourth quarter to 3.0 per cent, followed by a 25-basis-point cut in the following quarter to 2.75 per cent.

Inflation and the continuous price rise of food and oil should keep the bond market on the defensive. 

Thus, we expect a bearish curve-flattening trend to re-emerge this quarter. Thereafter, we expect the front-end of the baht rate curve to develop a bid tone next quarter, amid rate cut expectations in the last quarter. But long-end yields should underperform on supply concerns predicated on an anticipated hefty budget for fiscal 2009. Hence, we expect the government bond yield curve to pivotally grow steeper next quarter.