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The sell-off in the Thai bond market has been brutal of late, with June posting another bearish month. Government bond yields have risen by around 200 basis points from their lows in February/March earlier this year. The May Consumer Price Index was very high at 7.6 per cent year on year, while core CPI printed 3.6 per cent year on year, breaching the Bank of Thailand's target range of zero to 3.5 per cent. The central bank has been persistently hawkish, with the deputy BOT governor recently commenting that rate rises will ease inflation, but not hurt growth. Notably, real interest rates are negative and are low on a historical basis and versus regional markets, further adding to rate hike expectations.

We have revised our BOT policy rate outlook and now expect two 25-basis-point hikes in the third quarter of this year to 3.75 per cent from 3.25 per cent, before standing pat through the first half of 2009. Notably, this is still more dovish than market expectations, where the front-end of the interest rate swap curve is currently pricing in around 75 basis points of hikes by year-end.

 On supply, the Public Debt Management Office noted on June 18 that gross bond supply for the fiscal year 2008/09 could reach Bt500 billion, which hurt bond market sentiment. However, the Bt33 billion slated for the third quarter is much smaller than expected (of about Bt50 billion-Bt60 billion), which should offer the market some reprieve in the months ahead.

On the flow fronts, front-end interest-rate swaps may be pressured lower from pipeline baht-denominated bond issuance by foreign names, as the issuer swaps baht proceeds into US dollars before repatriating offshore. Already, the Finance Ministry has approved plans by 15 foreign institutions to issue Bt52.5 billion worth of baht-denominated bonds this year. Moreover, the South Korean relative value trade (buy one-year bond/pay cross-currency swap) will continue to exert downward pressure on the local swap curves.

Going forward, we expect to see a bullish steepening correction on the Thai government bond and interest-rate swap curves. We are more dovish than consensus on BOT policy rate expectations, and although fiscal 2008/09 supply looks large, the quantum slated for the third quarter is manageable. As mentioned above, potential flows should also pressure the interest-rate swap curve lower and lead to bond/swap spread narrowing, which are now very wide on a historical and statistical basis.

 

Danny Suwanapruti is a fixed-income strategist at Standard Chartered Bank based in Singapore.