Looking behind foreign inflows to the Thai bond market
Foreign-bond inflows to Thailand are estimated to have been fairly robust since the start of this year. What can be driving this Typically, foreign investors look at three key components when deciding whether to buy Thai government bonds - duration, carry, and foreign exchange.
What is the potential return on duration If the central bank is in an easing cycle, then a bond investor would typically expect duration gains in the form of yield declines. That is, investors expect capital gains on the appreciation of the bond price.
Carry is typically defined as the yield in excess of funding cost, for example the London Interbank Offered Rate, or Libor. However, offshore real money accounts are mostly long in cash and just look at absolute yield levels as a measure for carry.
The most commonly tracked bond-market index for government bonds in emerging markets is the Global Bond Index-Emerging Markets Global Diversified (GBI-EM). This index covers 15 government-bond markets - Nigeria, Brazil, Russia, South Africa, Turkey, Hungary, Chile, Indonesia, Mexico, Colombia, Peru, Poland, the Philippines, Thailand and Malaysia. Note that Thailand has a weighting of 7.2 per cent.
Foreign exchange is another key, if not the most important, component in an investor's decision-making. Given that central banks are more or less done with their easing and that the volatility of government-bond market yields is relatively low, the largest returns on bond portfolios are likely to come from FX.
Having considered these three factors, we look at how this is relevant for Thailand.
There is some scope for duration gains, as the central bank could cut the policy rate by 25 basis points - our house's view. But the duration gains are not likely to be massive, namely just 50 basis points or so, and not like the 200-400-point moves we saw in Eastern European markets last year.
In terms of carry or the yield differential against US dollar rates - using the Fed Funds rate or 3M Libor as a proxy - Thailand offers the second-lowest yield in the GBI-EM, after Malaysia. So for investors searching for carry, there are several other emerging markets such as Turkey, Brazil, South Africa and Hungary that are easily accessible and are more attractive.
FX is usually the charm point of the Thai market. Offshore investors have typically found the baht less appealing versus, say, the South Korean won, Malaysian ringgit or Philippine peso. This coupled with its low yield has meant that investors are generally underweight the Thai bond market versus the GBI-EM. However, when the baht rallies, investors underweighting FX have to cover their positions and short cover, which is what we noticed in January.
Danny Suwanapruti is a senior rates strategist for Standard Chartered Bank in Singapore.
GBI-EM Global Diversified Markets (10-year yield in each bond market)
Nigeria (%) 10.64
South Africa 6.82
Sources: Danny Suwanapruti and Bloomberg