.Mean KBank S Capital Markets Perspectives

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1 .Mean KBank S Capital Markets Perspectives Market Calls Yellen s Bluff, While the Outlook for Baht Changes Strategies on Macro / FX/ Rates 17 March 216 The FOMC decided to hold its benchmark rate at.25% -.5% The FOMC revisited its stance on hiking rates four times to two times this year Global economic developments weigh down on the outlook, as the slowdown in Japan, Europe, and emerging economies may have an adverse impact on the US economy The US economy continues to grow at a moderate pace, with the labor market outperforming the others However, given the downside risks to growth, the Fed revises down economic forecast for 216 While negative rates are not yet a possibility for the US, the negative rates elsewhere have pushed one third of nominal bond yields in developed markets below zero As the pool of investible assets shrank, anything that give return more than zero seems to be attractive This reinvigorates the hunt for yield theme and thus downplay some strength of the dollar The three most influential factors for USD/THB outlook are 1) global easing outweighs Fed tightening 2) high current account surplus to make USD/THB heavy, and for medium-term 3) risk from China s policy move We expect the BOT to join the easing party by 2Q16 as the MPC cut repo to record low at 1.25% We expect USD/THB to hover around 35.5 at the end of 2Q16 and 37. by year-end 216 Anchali Singh Kasikornbank anchali.s@kasikornbank.com Pareena Phuangsiri Kasikornbank pareena.p@kasikornbank.com Disclaimer: This report must be read with the Disclaimer on page 9 that forms part of it Fed maintains rate, and eyes two rate hikes this year In last night s monetary policy meeting, the FOMC decided to hold its benchmark rate steady at.25% -.5% as expected. The FOMC, in a 9-1 vote, decided to keep its rate steady. The only member who voted for a rate hike was Esther George, one of the most hawkish members of the FOMC. This decision came largely in line with market expectation, which had priced in on no hikes in this meeting. However, markets do expect the Fed to hike rates in the future; with the probability of a June hike standing at 36.6%, the probability of a July hike standing at 43%, and 53% for September. As such, the market does expect the Fed to hike rates in the future. 1

2 The Fed revisited its stance on hiking rates four times to hiking rates two times this year. In a revised dot plot, the Fed projected that it expects to hike rate twice this year. Earlier in December, the Fed signaled that four rate hikes would be appropriate for the year of 216. In her testimony, Fed Chair, Janet Yellen remained prudent about the future of rates in the United States. Stating that, caution is appropriate, Yellen remained appeared more dovish than usual, as global economic outcomes weighed on her mind. Essentially, while it may appear that the Fed is leaning to be a conformist to the ease monetary policy to stimulate the economy group, the Fed isn t essentially holding rates to stimulate its economy, but rather to cushion its economy from global shocks. This also goes on to show that policy doesn t necessarily walk on a pre-set path, and the Fed is increasingly becoming more data dependent in its decision to hike rates. Essentially, the committee believes that a two time hike will be more conducive to the US economy, which is growing at a slow and gradual rate. Fig 1. Infamous FOMC s dot plot from March 216 meeting Source: FOMC, KBank Janet Yellen remains cautious, and appeared more dovish than earlier meetings. In her press conference, Janet Yellen, admits that the current rate stands in a comfortable range of.25% -.5%, where policy makers have a greater scope to respond to a change in outlook. Essentially, she expressed the fact that given scenario, policy makers would find it easier to react to an upside surprise in the US or global economy; however, if the Fed had cut rates in its March meeting, it might have found it difficult to react to an unexpected slump in the global or US economy. As such, the Chair of the Federal Reserve remained cautious about the rate-path in the United States, as she assessed the risk to the US economy. The Yellen of now seems different from the optimistic Yellen of December 215, when the US hiked rates for a first time in 9 years, and the dot plot signaled towards four hikes in 216. It seems like just like every other country, the US is worried about the impact of the developments of the global economy on its nation. 2

3 Global economic developments weigh down on the outlook Financial markets have had one of the most volatile starts this year. The Chinese economy has been struggling with low exports, and increased capital outflows from the country. The European economy continues to stagnate, as its inflation dips lower into the negative territory. Japan, too, lingers in an inert state of growth, as its exports struggle. In addition to this, the possibility of a Brexit looms large on the horizon. As such, most developed economies have retained their stance on accommodative monetary policy. For instance, China recently cut its reserve requirements, in order to incentivize banks to lend more. The European Central Bank just unveiled a massive stimulus package, while also cutting all of its major rates. Furthermore, Japan remains open to exploring further negative rates, stating that theoretically, it could support a -.5% interest rate. Given this, the global economy continues to struggle. Thus, given that the world economy is more open than it was half a decade ago, the United States is likely to feel the impact of such developments in the world economy. In light of these events, if the Fed tightens its monetary policy, the economy might struggle to grow. Additionally, given that the dollar remains as one of the main reserve currencies in the world, with central banks around the world retaining their holdings of the dollar at 64%, a tighter US monetary policy, may worsen the outlook for the global economy. For instance, if the Fed hikes rates, the dollar will strengthen; as a result, the Chinese economy may suffer further from pricier imports. Thus, a tighter US monetary policy may exacerbate the current slowdown around the globe, which, in turn, may only come home to undercut the growth in the US economy. The Fed isn t too concerned about oil prices. The movement in oil prices has been dominating market sentiments this year. However, the FOMC isn t too worried about the future of oil prices. Yellen admits that on studying micro data, there do appear to be some linkages between household spending and oil prices. For instance, given that oil prices are at a historical low, people are spending lesser money on fuel, and as such, are spending more money on eating out, or buying more clothes. However, on studying aggregate data, it appears that this linkage doesn t appear to be very strong. Thus, on an aggregate level, lower gasoline prices have not led to an increase in aggregate spending in the economy, and the linkage between oil prices and aggregate spending diminishes. Theoretically, a decrease in oil prices would lead to lower inflation, while an increase would lead to higher inflation. However, according to Yellen, the committee tends to look past the movement in oil prices, as the effect of oil prices on inflation appears to be transient. While the world slows down, the US continues to grow at a moderate pace Inflation showed some signs of improvement. Despite falling gasoline prices, inflation in the US showed signs of improvements. The year-on-year inflation rate for February currently stands at 1%. Even though it s below the Central Bank s target of 2%, it has come a long way from -.1 in December last year. Even though the overall inflation remained low due to low energy prices, core inflation continued to show signs of improvement. Inflation has mainly improved due to a pickup in the medical costs and rent. However the Fed believes that the pickup in inflation in the last few months may not be robust, as inflation has mainly improved due to a spike in categories that tend to be volatile and transient. Thus, the Fed will be monitoring inflation closely, in order to determine if the pickup in inflation is indeed a durable trend, to warrant rate hikes. Furthermore, the FOMC expects the core inflation to rise by a gradual rate to 1.6% by the end of this year. 3

4 Fig 2. Inflation in the US Fig 3. Job Market Continues to Improve Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 CPI MoM CPI YoY CPI ex Food & Energy Inflation Target Thousands K 188K 199K 259K 212K Change in non-farm payrolls Annual average Labor market continues to grow strongly. The labor market in the US continues to be one of the strongest performing sectors in the economy. The non-farm payrolls have been showing continues signs of growth, with February s numbers coming in better than the year s average. Furthermore, given that the Fed remains loyal to its objective of maximum unemployment at 4%, the US economy can be seen moving closer and closer to this target level. Furthermore, the average hourly earnings have also been growing at a rate closer to its target of 6%. Thus, it can be said, that the US labor market has been performing in a way that would make the Fed optimistic. If the labor market continues to strengthen despite external risks, a hold in rates may lead to an overshoot in inflation. Thus, looking forward, the Fed will continue to monitor the labor market closely, to decipher if the market is indeed resilient to global risks. Fig 4. Unemployment Rate & Average hourly earnings Fig 5. Revised Economic Projections 12% 11% 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % Unemployment rate Average hourly earnings growth GDP 216 Unemployment rate 216 PCE inflation 216 December 215 projection March 216 projection However, the FOMC cut its economic forecast for 216. Despite a strong job s report, and signs of improvement in inflation, the FOMC decided to cut its economic forecast for 216. The GDP was revised down by.2% to 2.2% and the PCE inflation was reduced by.4% to 1.2%. However, the unemployment rate forecast remained the same at 4.7%, while core inflation also remains unchanged at 1.6%. Even though the US economy has been performing relatively better, the Fed remains concerned about external risks. While the slowdown in China and emerging markets was in line with the Fed expectations, the unexpected slowdown in the Eurozone and Japan has cautioned the Fed to remain discreet in tightening its monetary policy. Additionally, the continued decline in oil prices has also mandated the FOMC to revise their figures lower. 4

5 Fig 6. FOMC's economic projection after March 16 Meeting Variable (%) Longer run Change in real GDP December projection Unemployment rate December projection PCE inflation December projection Core PCE inflation December projection Federal funds rate December projection Looking forward, what to expect from the Fed? The Fed is currently not thinking of negative rates. While many developed economies have taken the plunge into the negative territory, the Fed chair made it clear that the US is not considering negative rates. Given that the economy is on a path of slow and steady growth, such a path is far from the Fed s considerations. Even though the US is studying the effectiveness of negative rates in other countries, the Fed has yet to delve into the legalities of such a tool in the US. Furthermore, in the unlikely event that the Fed will need to succumb to monetary easing, the Fed still has a bag full of ammunition to stimulate its economy. Yellen also hinted that under such an event, and given the US s good experience with quantitative easing, the Fed would likely boost its economy through an asset purchase program. Rate hikes are still on the table. While the Fed remains cautious on hiking rates, with the dot plot now signaling only two hikes this year, Yellen has stated that April remains a live meeting to hike rates. As such, if the labor market continues to outperform, the Fed may become wary of a situation of inflation overshoot. Thus, even if global economic conditions remain unchanged, the Fed may be forced to hike rates in order to control the rise of inflation. However, it looks unlikely that the economy will evolve in such a way by April; and thus, markets only expect a 7.7% hike in rates in the FOMC s April meeting. However, given the gradual increase in the economy, the next hike in rate is more likely to come in June, or in months following it. Fig 7. Probability of Future Rate Hikes in 216 8% 7% 6% 5% 4% 3% 2% 1% % 68% 53% 56% 38% 43% 8% April June July September November December Probability of hike in each FOMC meeting in as of 16th March 5

6 All in all, even though the FOMC remains optimistic about developments in the US economy, it has become increasingly pessimistic about the evolution in the global economy. With downside risks to growth increasing, the FOMC would like to test the resilience of the newly revived US economy, before it goes on to hike rates. Essentially, the Fed is wary about hiking rates, in case a tighter monetary policy and the slowdown in the global economy, undercuts their years of work into reviving the US economy. Thus, in this month s meeting, Yellen decided to maintain her alliance with doves, rather than flying with the hawks. New (ab)normal policy likely to yield new (ab)normal consequences Global economic divergence theme has aggravated even further in 216. Although the Fed started to normalize its Fed fund rate for the first time in December 215, other major economies fragility and deflationary pressure forced many central banks to push the bar lower and resort to negative interest rates. This non-traditional policy tool should imply that the outcome will also be abnormal too. In fact, further easing can still be expected this year and this is likely to complicate both the Fed s job and our lives further as uncertainty and risk from policy mistake are likely to continue weighing on global growth and world trade outlook. Fig 8. Risk to global growth remains on the downside Fig 9. Several central banks employed non-traditional negative interest rate % YoY LATAM Eastern EU 5.9 Japan US World Thailand Asian (ex. JP) 216 (current forecast) Forecast change from 6 months ago 6.5 China Eurozone Sweden Switzerland Denmark ECB Japan Deposit rate at the central bank, % While we have always called for two rate hikes (5bps) in 216 from the Fed (which is in line with the Fed s most recent dot plot), the impact of negative rates from other major economies over capital flows movement globally have been underestimated. The negative rates have pushed nominal yields in developed markets bonds below zero (current about 3% of developed markets sovereign bonds yield negative nominal returns), which means that the pool of investible assets have shrank and anything that give return more than zero seems to be attractive. We now think that large existing global liquidity is likely to reinvigorate the search for yield theme and thus downplay some strength of the dollar rise. We take this opportunity to review our current call on USD/THB for year-end 216 and release the target for 2Q16. In our humble view, we think there are three most influencing factors underlying USD/THB outlook, namely global easing trend, persistent current account surplus and China s policy uncertainty. Global easing vs. Fed s tightening: With the rest of the world being biased on the easing side, the Fed has to trim down its path of tightening. More foreign capital inflows are expected for broad emerging markets. This is likely to cause emerging market s assets gain over the next month or two. 6

7 Anyhow, we expect the markets to revisit the idea of Fed s rate hike again as June s FOMC meeting approach. The moderate growth in the U.S. driven by resilient U.S. job market should still allow the Fed to hike rate this year. We penciled in the next hike in June and another at the end of 216. From domestic perspectives, we see increased risk that the Bank of Thailand (BOT) will also join the easing party. The strength in THB is one of the key catalysts for further easing while adverse impact from drought on the economy during 2Q should provide reason on a cut. We expect the MPC to trim repo rate the record-low level at 1.25% by 2Q216 on downside for domestic growth. Narrowing interest differentials between Thailand and U.S. will be the important factor pushing USD/THB higher from here. Fig 1. The Fed will continue to tighten but MPC will join the easing party Fig 11. Thailand s current account surplus have been large and should remain high in 216 USD mn 4, 3, 2, 1, -1, -2, -3, BOT repo Fed Funds Current Account Financial account Net position High current account surplus should make USD/THB more heavy: Judging from fundamentals, the current account surplus is expected to remain high in 216 following faster contraction in imports than exports. Our house s forecast on current account surplus for 216 should stay elevated at USD23.3bn, compared to THB34.8bn last year. This is the reason why we have seen USD/THB being stickier than other Asian FX this year and this factor is likely to help prevent large spike in the pair thus putting our previous call on USD/THB at risk. Given the above mentioned factors, we see the current downside to USD/THB move in the short-term at around 34.3 from the Fed dovishness, global easing theme and thus foreign inflows. Yet, June s hike and MPC s cut are likely to send USD/THB on a rising path again towards the end of 2Q16. We expect USD/THB to hover around 35.5 by the end of 2Q16. 7

8 Fig 12. China s economy is not out of the woods; it is a matter of time before policymakers will act again Official PMI expecting expansion expecting contraction Caixin PMI Fig 13. New USD/THB target for 2Q16 at 35.5 and 37. for year-end 216 KBank USD/THB model Jan-9 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 actual model -2SE +2SE For year-end 216, we tilted our call on USD/THB to 37. from 38.. Beside, another hike from the Fed at the year-end, one important risk that we do not yet rule out is the move from China. Despite the recent calmness in the Chinese financial market, economic weakness remains unchanged. Manufacturing PMI has been in a negative territory for almost a year despite some resilience in retail sales, we think service sector will not be able to compensate for the slowdown in hard sector. Such economic weakness is likely to push for both fiscal and monetary easing and it will likely to result in higher USD/CNY. Even though the policymakers can buy time for now, they will have to act again in 2H16 and that that is likely to have the impact on USD/THB move. 8

9 9 Disclaimer For private circulation only. The foregoing is for informational purposes only and not to be considered as an offer to buy or sell, or a solicitation of an offer to buy or sell any security. Although the information herein was obtained from sources we believe to be reliable, we do not guarantee its accuracy nor do we assume responsibility for any error or mistake contained herein. Further information on the securities referred to herein may be obtained upon request.