MOST MARKET participants believe the expected hike in the fed funds rate and subsequent narrowing of the policy rate differential will weigh on the baht this year.
But up to now, that expectation has been far off the mark. The fed funds rate did end up rising 50 basis points to 1-1.25 per cent, close to the Thai policy rate of 1.5 per cent. And the so-called policy rate gap did decline to the lowest level in almost a decade.
But the baht has seemed to defy gravity, strengthening by 8 per cent against the dollar so far this year to be one of the best performing currencies in the world.
The most plausible explanation lies in the real interest rate. Although the Bank of Thailand has stood pat, the rapid fall in inflation has caused the real interest rate in Thailand to rise vs the US, in turn exerting upward pressure on the baht.
Thailand’s inflation rate is among the lowest in the world.
The price measure plummeted more than 1 percentage point in the first half of the year to a negative 0.05 per cent in June due mainly to the drought that pushed up food prices in the first half of last year.
For the rest of this year, we expect inflation to recover as the high base effect fades. This should reduce the real interest rate and the strengthening pressure on the baht.
The nominal policy rate in the US should continue to rise as the Fed unwinds its policy. We expect one more rate hike in 2017 and three more in 2018, while we expect the Bank of Thailand to keep its policy rate steady at 1.5 per cent at least until December 2018.
Consequently, we expect the Thai real policy rate to begin to fall and the effect of the narrowing nominal policy rate differential to manifest itself over the rest of the year.
US politics has also played a crucial role in the slump of the greenback. President Trump’s failure to deliver on his pro-growth policy promises has led to a reversal of “Trump-flation” trades and a sell-off in the US dollar.
According to the CFTC Commitment of Traders report, speculative net long positions in the USD, reflecting hedge fund bets on the currency to strengthen, peaked last December and plunged rapidly last quarter to a three-year low.
The prospects for major fiscal stimulus in the US will remain elusive in the next few months as Congress is tied up with pressing issues such as raising the debt ceiling and passing the spending bill to prevent a government shutdown.
In the medium term, however, pro-growth policies such as tax reform and financial deregulation will likely return to the agenda in October and could provide a positive catalyst for the dollar in the fourth quarter.
The reversal of Trump-flation trades and the subsequent decline in global bond yields has also triggered a new leg of fund flows into emerging market assets.
Year-to-date, foreign investors have amassed Bt200 billion in Thai bonds and Bt4 billion in Thai stocks.
However, the foreign portfolio flow came to a halt in June and recently reversed as major central banks shifted toward a more hawkish stance. The continued tightening of monetary policies could trigger another sell-off in emerging market assets, causing EM currencies including the baht to retreat against major currencies.
In particular, the Fed is widely expected to announce next month its plan to begin downsizing its massive bond portfolio – a move that will lead to the gradual draining of liquidity from financial markets.
The European Central Bank will likely follow this by announcing its own plan to put its qualitive easing programme on a diet, probably next year.
KOMSORN PRAKOBPHOL, the head of strategy at the Tisco Economic Strategy Unit, can be reached via www.tiscowealth.com or firstname.lastname@example.org.