Steep yield curve makes Thai bonds investor darlings

SINGAPORE (REUTERS) - Investors, both non-resident and domestic, are rushing into Thai government bonds, betting that the combination of a steep yield curve and a dovish central bank will lead to an outperformance of this market over other Asian bond markets.

Foreign investors have pumped a net US$3.1 billion (S$3.9 billion) into Thai government bonds in the past month, driving yields down far more than in markets such as Malaysia, Philippines or even South Korea, whose central bank is also more likely to cut rates than raise them in the near future.

"It is everybody's darling, in a sense, because the bond curve and swap curve are quite steep," said Mr Claudio Piron, currency and rates strategist at BofA Merrill Lynch in Singapore.

"The curve is implying the Bank of Thailand will hike by 25 basis points in a year's time, the carry and slide looks very attractive and policy looks quite tight," he said.

The Thai bond and swap curves have been steepening since July, which meant a wider gap between short and long term yields, when the Bank of Thailand said the economy was weakening while inflationary pressures were easing.

That led to market participants pricing in more rate cuts, driving short end yields down sharply.

The spread between 5-year and one-year bonds is 97 basis points (bps), while that between 10-year and 2-year interest rate swaps is 1.23 percentage points.

Yet, not much foreign money went into Thailand, or any other Asian bond market for that matter, during July and August as investors worried about the US Federal Reserve's possible policy tapering and resultant capital outflows from emerging markets.

Assured by the outcome of the mid-September Fed meeting that US policy tapering would both be delayed and gradual, investors returned to emerging markets, although they remained picky and cautious.

Ten-year Thai bond yields have declined 55 bps in a month, compared with 15 bps in Malaysia, and 14 bps in Korea.

Philippine bond yields have risen 10 bps in the same period.

Analysts at Deutsche Bank said they were being selective about carry trades in the region but Thai bonds were the "best policy carry trade".

The Thai yield curve was pricing in between one to two rate rises over the next 6 months, which was excessive when compared with the central bank's dovishness and with how inactive they have been in the currency swaps market, Deutsche analysts Sameer Goel and Kiyong Seong said in a note to clients.

Core consumer inflation was 0.6 per cent in September over a year ago, almost hitting the lower end of the BOT's 0.5-3.0 per cent target range. That leaves the policy rate at 2.5 per cent pretty high, when adjusted for inflation.

But the slide or rolldown is what investors find most attractive.

The steep Thai curve, where swap levels move at least one basis point higher each month, give investors ample downside protection should rates move the other way. They also help investors assign better current values to their bullish positions, based on projected rates from the curves.