Thailand’s government bond market looks overvalued

It’s doubtful the deep discount on Thai bond yields versus the risk-free US Treasury curve will hold this year

Illustration by Sara Sen
Illustration by Sara Sen

WHEN I look at the Southeast Asian yield curve complex, I’m somewhat staggered by the most standout optic: Thailand’s 10-year government bond, which at 2.36% trades substantially through the like-tenor point on the US Treasury yield curve, which printed at 2.88% as this column was being written.

There are reasons for this wide spread relationship, although one wonders quite whether these reasons will hold over the course of this year.

One of the primary reasons is low inflation, as well as persistently weak domestic demand. In terms of its Southeast Asian peer group, Thailand’s GDP came in as a damp squib of 4% last year, underperforming its neighbours, although that rate wouldn’t be regarded as too shabby if such a rate of growth were to be achieved in the developed economies.

The benchmark one-day repurchase rate is hovering around its all-time low of 1.5% and that rate appears unlikely to change given Thailand’s miniscule inflation rate which came in at an annualized 0.42% last month, undershooting analysts’ forecasts of a 0.69% gain.

In certain respects, Thailand faces problems which quite a few of its Southeast Asian peers would consider themselves lucky to own. The country has experienced a consistently appreciating exchange rate to the currencies of its major trading partners, runs the region’s biggest current account surplus, sits on a US$200 billion pile of reserves, and would indeed welcome the prospect of capital outflows to take some strain off the ever-appreciating baht.

It will probably take quite a lot to shift the “problems” in a hurry, particularly the disinflationary dynamic, as Japan has discovered following years of aggressively loose monetary policy. Indeed, given all of these cohabiting dynamics it might have been reasonable to place Thailand on the list of countries which might have been candidates for moving to negative interest rate territory.

But somehow I doubt whether the deep discount on Thai bond yields versus the risk-free US Treasury curve will hold as the Federal Reserve moves this year, with newly installed Fed chairman Jerome Powell flagging the likelihood of four rate rises in 2018.

That would be on the view that there will be a degree of capital flight out of the Thai government bond market as medium to long end rates normalize in the US debt market complex. That in fact would take the strengthening pressure off the Baht and might encourage a modicum of imported inflation – just what the Thai monetary authorities have been seeking.

There is another vague risk factor surrounding the Thai currency and its rates market, and that is the fact that the country runs a US$20 billion-odd annual trade surplus with the US. Although President Donald Trump has so far acted on his campaign pledge on tariffs just to the steel and aluminum markets, there are fears that he will attempt to chip away at what he regards as egregious US trade deficits elsewhere.

For that reason I anticipate increased volatility in Asian local currency bond markets and imagine that selling five-year Thai CDS against regional peers based on its outright richness is a worthwhile gambit.