.Mean S KBank Multi Asset Strategies Strategies...1 .Mean S Strategic Thesis OPEC nations in 2016...

1

.Mean S

Strategic Thesis OPEC nations in 2016 are mostly stuck in a prisoners’ dilemma and have no other choice but to pump as much as possible in a game of mass economic suicide to cull out the weak and select the surviving few. As the OPEC prisoners’ dilemma continues, central banks are at their wit’s end on how to gain and / or keep the markets’ trust that they are able to steer inflation in the right direction and magnitude. This revives the theme of global monetary easing. The ECB’s meeting minutes show that the ECB’s main concerns are not in underlying economic indicators, but on deflationary pressure. However, we view that the economic backdrop has deteriorated since December, and could add further pressure to the GC. Despite external weakness, the Eurozone’s domestic demand, which is the Eurozone’s major economic driver over the past years, is likely to decelerate going forward. The ECB cannot afford to let the economy decelerates and feed into a deflation spiral. The distorted interest rate places limit on the universe of investible assets, pushing more money out for better returns elsewhere. Looking at the case study from Japan, we found that the real winner from Japanese money flood has been the U.S. markets. Inflows to both fixed income and equities outperform the rest of the world. Anyhow, Japanese inflows to bond markets has persistently outperformed that of stocks and it is likely to continue. It should be noted that despite the new round of global easing, there has been a disconnection between local and foreign bond flows; market resilience has been mainly supported by domestic investors. We shift the priority of the most influential factor for fixed income market from Fed fund rate normalization to existing onshore liquidity following strong onshore demand, likely to keep yield at subdued level.

Kobsidthi Silpachai, CFA –Kasikornbank [email protected] KResearch

[email protected]

� OPEC nations in 2016 are mostly stuck in a prisoners’ dilemma

and have no other choice but to pump as much as possible…

� But as the OPEC prisoners’ dilemma continues, central banks are

at their wit’s end on how to keep the markets’ trust by steering

inflation through easing policy

� With the BoJ’s easing policy and the Eurozone’s high exposure to

emerging markets, the pressure for the ECB to deliver is higher

� Investors positioned cautiously given the glaring disappointment

in December

� China’s miraculous growth cannot be sustained forever, unless

there is continuous innovation and technological advancement

� Despite the theme of global monetary easing, there has been a

disconnection between local and foreign bond flows. Thai

market resilience was mainly supported by domestic investors

� Other positive factors for Thai bonds are 1) lighter traffic from

BOT, SOE and corporate bonds 2) excess liquidity from large

banks and 3) cost of going offshore is not attractive

KBank Multi Asset Strategies The Global Economy ….it is complicated

Strategies

Macro / Multi Asset

March 2016

Volume 105

“KBank Multi Asset

Strategies”

can now be accessed on

Bloomberg: KBCM <GO>

Disclaimer: This report

must be read with the

Disclaimer on page 40

that forms part of it

2

Key Parameters & Forecasts at Year-end

2008 2009 2010 2011 2012 2013 2014 2015 2016E

GDP, % YoY 1.7 -0.7 7.5 0.8 7.3 2.8 0.9 2.8 3.0

Consumption, % YoY 2.8 -1.3 5.0 1.8 6.3 0.8 0.6 2.1 2.1

Government spending, %YoY 4.9 10.3 9.3 3.4 7.5 4.7 1.7 2.2 2.8

Investment Spending, % YoY 2.3 -10.9 11.6 4.9 10.2 -0.8 -2.6 4.7 4.6

Export (USD term), % YoY 15.9 -13.9 27.1 14.3 3.0 -0.1 -0.3 -5.8 2.0

Import (USD term), % YoY 26.7 -25.1 37.0 24.9 8.4 -0.1 -8.5 -11.0 5.5

Current Account (USD bn) 0.9 20.7 10.0 8.9 -1.5 -5.2 15.4 34.8 23.3

CPI % YoY, average 5.5 -0.9 3.3 3.8 3.0 2.2 1.9 -0.9 1.2

Fed Funds, % year-end 0.0-0.25 0.0-0.25 0.0-0.25 0.0-0.25 0.0-0.25 0.0-0.25 0.0-0.25 0.25-0.50 0.75-1.0

BOT repo, % year-end 2.75 1.25 2.00 3.25 2.75 2.25 2.00 1.50 1.50

Bond Yields

2yr, % year-end 1.98 2.17 2.35 3.10 2.88 2.62 2.11 1.57 1.60

5yr, % year-end 2.2 3.6 2.75 3.15 3.15 3.41 2.48 1.96 2.00

10yr, % year-end 2.7 4.3 3.25 3.30 3.52 3.98 2.83 2.50 2.75

USD/THB 34.8 33.3 31.4 31.54 30.60 32.68 32.91 36.03 38.00

USD/JPY 90.7 93.0 82.0 76.9 85.8 104.9 119.7 120.22 122.0

EUR/USD 1.40 1.43 1.40 1.29 1.32 1.38 1.21 1.09 1.08

SET Index 450.0 734.5 1,032.8 1,025.3 1,391.9 1,299.0 1,498 1,288 1,450

Source: Bloomberg, CEIC, KBank, KResearch, KSecurities

KBank Thai Government Bond Rich / Cheap model

-30

-20

-10

0

10

20

30

LB15

DA

LB16

7A

LB16

NA

LB17

6A

LB18

3A

LB18

3B

LB19

3A

LB19

6A

LB19

8A

LB21

3A

LB21

DA

LB23

3A

LB23

6A

LB24

DA

LB25

DA

LB26

7A

LB27

DA

LB29

6A

LB32

6A

LB38

3A

LB39

6A

LB40

6A

LB41

6A

LB44

6A

3 mth avg Now

bps (actual YTM vs. model)

Source: Bloomberg, KBank

3

KBank THB NEER Index KBank USD/THB – FX Reserves / USD Majors model

KBank THB Trade Weighted Index

107.6

75

80

85

90

95

100

105

110

115

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Jan 1995 = 100

+

1

-

1

28.0

29.0

30.0

31.0

32.0

33.0

34.0

35.0

36.0

37.0

38.0

39.0

Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

actual model -2SE +2SE

KBank USD/THB model

Source: Bloomberg, KBank Source: Bloomberg, KBank

FX reserves – USD/THB model DXY – USD/THB model

y = -6.8961Ln(x) + 67.437

R2 = 0.9662

28

30

32

34

36

38

40

42

44

46

48

0 50 100 150 200 250

y = 30.041Ln(x) - 98.308

R2 = 0.6371

27

29

31

33

35

37

39

41

43

45

47

70 75 80 85 90 95 100 105 110 115 120 125

DXY to USD/THB mapping current

USD/THB

DXY

since 2001


KBank BOT repo model SET forward dividend yield vs. bond yields

0.00.51.01.52.02.53.03.54.04.55.05.5

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

actual model

%

1.9

2.4

2.9

3.4

3.9

4.4

4.9

10 11 12 13 14 15 16

10yr yields SET forward dividend yields

%


Thailand’s GDP growth Thailand’s GDP growth

0.2

-0.6

0.80.2

0.7 0.9 1.2

0.3 0.31.0 0.8

5.3

2.7 2.6

0.9 1

3 2.8 2.9 2.8

-0.7

0.7

-0.4

2.1

-2

-1

0

1

2

3

4

5

6

7

8

1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15

GDP %QoQ SA GDP %YoY

3.0 2.7 2.9 2.8

-6

-4

-2

0

2

4

6

8

1Q15 2Q15 3Q15 4Q15

Private consumption Govt consumptionInvestment Net exports of goodsNet exports of services Stock&StatGDP (CVM)

%pt contribution to YoY GDP

Source: NESDB, KBank Source: Bloomberg, CEIC, KBank

4

Thai inflation parameters Thai government bond, yield to duration ratio

-3%

-2%

-1%

0%

1%

2%

3%

Jan-14 Jul-14 Jan-15 Jul-15 Jan-16

Energy (11.4%)

Raw food (15.52%)Core CPI (73.09%)

Headline CPI

YoY

30

40

50

60

70

80

90

100

110

120

130

06 08 10 12 14 16

y ield to duration, bps -1sd average +1sd

Source: Bloomberg, KBank Source: CEIC, KBank

Implied forward curve: TGBs Implied forward curve: USTs

1.20

1.45

1.70

1.95

0 1 2 3 4 5 6 7 8 9 10

04/03/2016

next 3 months

next 6 months

next 12 months

tenor, yrs

% Thai govt bond implied curve shifts

0.270.45

0.650.89

1.05

1.39

1.691.88

0.911.01

1.131.26

1.731.92

2.07

0.95

0.00

0.50

1.00

1.50

2.00

2.50

0 1 2 3 4 5 6 7 8 9 10

07/03/2016

next 3 months

next 6 months

next 12 months

% US govt bond implied curve shifts


Foreign holding of Thai fixed income and stock Mapping BOT repo vs. 2-10 spreads

603537

266

70

-143.3-150

-50

50

150

250

350

450

550

650

07 08 09 10 11 12 13 14 15 16

Thai government bonds BOT bond Thai stocks, est since 1999

THB bn

1.5, 96.5

y = -58.396x + 280.18

R2 = 0.4641

-50

0

50

100

150

200

250

300

350

400

1.00 1.25 1.50 1.75 2.00 2.25 2.50 2.75 3.00 3.25 3.50 3.75 4.00 4.25 4.50 4.75 5.00

BOT repo - policy rate, %

2 - 10 spreads, bps

Source: Bloomberg,ThaiBMA, KBank Source: Bloomberg, KBank

5

KBank EUR/THB model KBank JPY/THB model

34

36

38

40

42

44

46

11 12 13 14 15 16

actual model

EUR/THB

25

27

29

31

33

35

37

39

41

43

11 12 13 14 15 16

actual model

JPY/THB


KBank GBP/THB model KBank CNY/THB model

42

44

46

48

50

52

54

56

58

11 12 13 14 15 16

actual model

GBP/THB

4.4

4.6

4.8

5.0

5.2

5.4

5.6

5.8

11 12 13 14 15 16

actual model

CNY/THB


KBank SGD/THB model KBank AUD/THB model

23.0

23.5

24.0

24.5

25.0

25.5

26.0

26.5

11 12 13 14 15 16

actual model

SGD/THB

24.0

25.0

26.0

27.0

28.0

29.0

30.0

31.0

32.0

33.0

34.0

11 12 13 14 15 16

actual model

AUD/THB


6

The Global Economy (& oil) ….it is complicated

The global economy…it is complicated

Iran was once a staunch ally of the US. One can tell how close the diplomatic ties with Super Powers like the US are by looking at that nation’s military arsenal. The Grumman F14 was once the US’s top jet fighter in the navy. During the cozy times of pre 1979, the only other country that had this air superiority jet fighter was Iran. In 1979, Iran underwent a revolution from a monarchy to become an Islamic republic while the US shifted from being Iran’s friend to its foe. Today, it seems that the US Congress has learnt a lesson, never to sell its top weaponry to any ally, no matter how close the relationship of the present maybe. Today’s US top jet fighter is the Lockheed Martin F-22 Raptor, in which the US Congress has an export ban in order to help maintain the US’s military superiority. Still, recently, tensions between the US and Iran are less cold as Iran would abstain from its nuclear program (uranium enrichment) while the US will lift its sanctions such as the release of frozen funds abroad and terminating the export ban of Iranian oil. US allies that are displeased with such developments are countries like Israel and Saudi Arabia, raising geopolitical risks on historical antagonism. Fig 1. Top tech fighter of the 1970s, F14 Fig 2. Top tech fighter of today, F22

Source: https://en.wikipedia.org/wiki/Grumman_F-14_Tomcat Source: https://en.wikipedia.org/wiki/Lockheed_Martin_F-22_Raptor

Economically, these expectations of rekindling closer ties between the West and Iran of the pre 1979 revolution has led to anticipation of a jump in global oil supply. Prior to the 1979 revolution, Iran too was ruled by a monarch - Mohammad Reza Shah Pahlavi. Presently, the government of Saudi Arabia is finding it tough to make ends meet as reflected by its falling oil revenues and a growing gap versus expenditures. This could be a prelude to growing social and political tensions. According to their budgets, Saudi Arabia is expected to book a fiscal deficit of SAR 326 bn. Recently, such concerns of Saudi Arabia’s financial health was reflected by S&P decision to downgrade the country’s rating from " A+ " to "A- ".

Kobsidthi Silpachai, CFA - Kasikornbank [email protected] Pareena Phuangsiri - Kasikornbank [email protected] Nattariya Wittayatanaseth –Kasikornbank [email protected] Anchali Singh – Kasikornbank [email protected]

7

Fig 3. The Shah of Iran Fig 4. Saudi Arabia’s fiscal position deteriorates

840

514

0

100

200

300

400

500

600

700

800

900

929394959697989900010203040506070809101112131415161718

revenue, SAR bn oil revenue expenditure

Source: https://en.wikipedia.org/wiki/Mohammad_Reza_Pahlavi Source: Bloomberg, CEIC, Reuters Eikon, KBank

Given these circumstances, the government of Saudi Arabia seems to be caught between a rock and a hard place since limited oil revenues from the collapse in prices and its citizen’s dependency from state sponsorship puts into question of political stability. Conspiracy theorists might proposed that it is in Tehran’s interest to pump as much oil as possible to keep Saudi Arabia’s oil revenue as depressed as possible in hopes of destabilizing Riyadh, reflecting the long run stand off between Shia and Sunni denominations of Islam. It is no wonder as to why Saudi Arabia’s credit rating was downgraded by S&P from " A+ " to "A- ". As shown on fig 4, OPEC’s number 1 is budgeted a total fiscal expenditure of SAR840 billion versus total state revenue of SAR514 billion, an implicit SAR326 billion deficit. It begs the question then, how on earth will Riyadh finance this shortfall….sell the family jewels? That is what might actually be happening as talks of doing IPOs for Saudi Aramco gain momentum. Possibly, Riyadh’s sovereign wealth funds might have been selling assets to raise cash and had inadvertently been adding to the global selling pressure on risk assets?

8

Fig 5. Oil supply / demand balance

mm barrels / day 03-14 06-14 09-14 12-14 03-15 06-15 09-15 12-15

Balance 1.2 1.5 0.5 1.0 2.1 2.7 1.7 1.7

Balance: excl Non OPEC Supply & OPEC NGLs 28.7 28.3 29.8 29.2 28.9 29.2 30.6 30.6

Demand 90.2 90.2 92.0 92.8 92.1 92.0 93.8 93.9

Demand: OECD 45.7 45.0 46.0 46.6 46.5 45.4 46.5 46.6

Demand: OECD: Americas 23.9 23.8 24.4 24.7 24.2 24.1 24.8 24.8

Demand: OECD: Europe 13.0 13.6 13.9 13.6 13.6 13.6 14.1 13.5

Demand: OECD: Asia Pacific 8.9 7.7 7.7 8.4 8.7 7.7 7.6 8.2

Demand: Developing Countries 29.4 29.8 30.4 29.7 30.0 30.7 31.3 30.5

Demand: Former Soviet Union 4.4 4.2 4.6 4.9 4.4 4.3 4.6 5.0

Demand: Other Europe 0.6 0.6 0.6 0.7 0.7 0.6 0.7 0.7

Demand: China 10.1 10.6 10.3 10.9 10.4 11.1 10.7 11.1

Supply 91.4 91.8 92.5 93.9 94.1 94.7 95.5 95.6

Supply: OECD 23.5 23.9 24.1 24.9 25.2 24.9 25.3 25.2

Supply: OECD: Americas 19.2 19.9 20.2 20.7 21.0 20.7 21.1 20.9

Supply: OECD: Europe 3.8 3.5 3.4 3.7 3.7 3.8 3.7 3.8

Supply: OECD: Asia Pacific 0.5 0.5 0.5 0.5 0.4 0.4 0.5 0.5

Supply: Developing Countries 12.2 12.2 12.4 12.6 11.6 11.5 11.4 11.5

Supply: Former Soviet Union 13.5 13.4 13.4 13.5 13.7 13.6 13.6 13.7

Supply: Other Europe 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1

Supply: China 4.3 4.3 4.2 4.4 4.3 4.4 4.4 4.4

Supply: Processing Gains 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.2

Supply: Non OPEC Members 55.8 56.1 56.4 57.7 57.1 56.7 57.0 57.0

Supply: OPEC Natural Gas Liquids & Non-Conventional s 5.8 5.9 5.8 5.9 6.0 6.1 6.2 6.3

Supply: Non OPEC and OPEC NGLs 61.5 61.9 62.2 63.6 63.1 62.8 63.2 63.3

Exports: Former Soviet Union: Net 9.1 9.1 8.8 8.6 9.2 9.3 8.9 8.7

Est. OPEC supply 35.6 35.7 36.1 36.2 37.0 38.0 38.5 38.6 Source: Bloomberg, CEIC, Reuters Eikon, KBank

It is interesting to note that the US Treasury does not reveal how much of its finance is funded by Riyadh i.e. how much does the oil rich kingdom holds in US Treasuries. Still, we took the toil to look at the balance sheet of Saudi Arabia’s central bank for clues and they are not encouraging indeed. Fig 6 shows that Saudi Arabia’s central bank – SAMA has seen its balance sheet plummet as it believe to be liquidating holdings in foreign securities (fig 7) in an attempt to compensate for lost oil revenues. In war, there are no winners; there are only losers only distinguished by losing big or bigger. While there are plenty of discussions that Saudi Arabia has the oil production cost advantage, one should factor in its social costs. Were Saudi Arabia a democracy, this social cost would be largely irrelevant. However, since Saudi Arabia isn’t a democracy, the powers that be, are aware of the risks of potential social unrests. Just look at history related to Louis XVI, Nicholas II, Wilhelm II, Charles I and more recently at Tiananmen Square or the Arab Springs. These social costs are reflected in the ballooning deficits of a resource curse. Fig 8 shows the IMF’s estimates of fiscal deficit of OPEC nations in 2016 as most are stuck in a prisoners’ dilemma and have no other choice but to pump as much as possible in a game of mass economic suicide to cull out the weak and select the surviving few.

9

Fig 6. Saudi Arabian Monetary Agency, SAMA’s assets

are plummeting

Fig 7. …as SAMA liquidates holdings in foreign

securities like US Treasuries?

2,840

2,373

0

500

1000

1500

2000

2500

3000

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18

SAMA assets, SAR bn

2,088

1,505

-

500

1,000

1,500

2,000

2,500

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18

SAMA investment in foreign securities, SAR bn

Source: Bloomberg, CEIC, Reuters Eikon, KBank Source: Bloomberg, CEIC, Reuters Eikon, KBank

Fig 8. OPEC budget deficit to GDP

-11.7

0.6

-1.6 -0.9 -1.0

-15.9-12.5

-63.4

-2.0

-0.7

-19.7

-3.8

-22.9

-70

-60

-50

-40

-30

-20

-10

0

10

Algeria

Ango

la

Ecuad

or

Indonesia

Iran

Iraq

Kuwait

Libya

Nigeria

Qatar

Saud

i Arabia

UAE

Vene

zuela

IMF 2016 budget / GDP est., %

Source: Bloomberg, CEIC, Reuters Eikon, KBank

(Inflation) control….is an illusion

In the 1999 blockbuster – The Matrix, the protagonist – Neo wanted to know what the Matrix was. Morpheus answered to Neo, “What is the Matrix…..control….” Contrary to the Matrix, it seems that monetary policy makers are lacking such a power. Despite throwing ever so much more money at the economy, supply doesn’t seem to create its own demand. Economics is an ongoing social science where its laws are governed by ever-changing human behavior unlike physical science where its laws are governed by nature and are absolute….maybe with the exception the domain of black holes. Try to break the laws of gravity and it will break you. Economist likes to peg things. Once upon a time, money was pegged to gold and then the US dollar. Now, money is pegged to inflation. Most developed economies have largely pegged their monetary policy to achieving a 2% inflation rate. In credit workout terminology, it is analogous to a “stand still” agreement hoping to stave off a price war. According to the purchasing power of parity (PPP), there is a relationship between inflation and exchange rates over the longer term. So, it could be viewed that if most developed economies choose to stick 2% inflation target, they are implicitly trying to keep their currencies relatively unchanged against one another.

10

Fig 9. Inflation targets / ranges of developed economies

1.7% 1.6%

0.1%0.4%

0.9%

2.1%

-1.0%

0.2% 0.1%

3.0%

-0.5%

-0.9%

0.8%

0.1%

-1.3%

0.2%

2.1%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

Austra

lia

Cana

da

Czech

Eurozone

Hun

gary

Iceland

Israel

Japan

New Zealand

Norway

Poland

Rom

ania

South Korea

Swed

en

Switzerland

UK

US

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%latest inflation data

point inflation rangeinflation target

Source: Bloomberg, CEIC, Reuters Eikon, KBank

But in as the OPEC prisoners’ dilemma continues, central banks are at their wit’s end on how to gain and / or keep the markets’ trust that they are able to steer inflation in the right direction and magnitude. It is actually tougher for central banks of emerging market to achieve their inflation targets since the bulk of their inflation basket are linked to commodities. Fig 10 attempts to demonstrate that oil will influence the price of food and eventually over all inflation and the integrity of central banks. Fig 10. source of mechanical energy influence source

of animal energy (food) Fig 11. …which in turn influence overall inflation and

faith in central banks

0

20

40

60

80

100

120

140

160

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

70

90

110

130

150

170

190

210

230

250

crude oil, USD per barrel, left FAO food price index, right

-40%

-20%

0%

20%

40%

60%

80%

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

0%

1%

2%

3%

4%

5%

6%

7%

8%

FAO food index, % YoY, left IMF world inflation, % YoY, right


The other prisoners’ dilemma….via monetary policy, interest rates / fx

Central banks are at their wit’s end on how to keep inflation from slipping away from their targets further into negative territory: Economics textbooks will generally offer explanations on about 3 arrays of monetary tools:

11

1. Policy rates (short term rates) to signal / guide the yield curve and set the price of

money with respect to time as conducive to the central bank’s inflation targets 2. Open Market Operations, better now known as “Quantitative Easing” or “QE”

entails the buying / selling of government bonds / assets with commercial banks. For example, if the central banks buy bonds from commercial banks, liquidity is being injected into the financial systems in hopes that more credit is created. On the contrary, if the central bank sells bonds to commercial banks, liquidity is being drained and commercial credits will contract.

3. Reserve requirements, are ratios imposed on the commercial banks to set aside a portion of their deposits in liquid assets e.g. deposits at the central bank. The higher the ratio, the less a commercial bank can redeploy the deposits as credits and vice versa.

4. While largely not officially recognized, exchange rates, we view very much deserve to be in this club of monetary tools. This is what Singapore’s Monetary Authority (MAS) uses. In layman’s terms, we view that interest rates is the price of money versus time while exchange rates is the price of money versus another country’s money. But in essence, it is the price of money, but differing on relative dimensions of comparison.

At present, many developed central banks have exhausted the first tool (policy rates) and have gone with the second tool i.e. QE. The problem for the ECB with regards to QE is a moral hazard issue. The more QE is executed by Draghi & Co., the more complacent the Eurozone governments become with regards to painful economic reforms which are likely to cost them their political power. No voter in his / her right mind would support a politician that could risk the voter their jobs. QE is a form of monetizing today’s public debt for future generations to pay. It becomes a moral issue indeed, no different from people who exploit today’s natural resources to leave a more polluted world for future generations to deal with. So now a growing number of developed central banks have crossed the line with policy rates towards negative rates. This would not have been conceptually possible were it not for an Indian mathematician:

During the 7th century AD, negative numbers were used in India to represent debts. The Indian mathematician Brahmagupta, in Brahma-Sphuta-Siddhanta (written c. AD 628), discussed the use of negative numbers to produce the general form quadratic formula that remains in use today. He also found negative solutions of quadratic equations and gave rules regarding operations involving negative numbers and zero, such as "A debt cut off from nothingness becomes a credit; a credit cut off from nothingness becomes a debt. " He called positive numbers "fortunes," zero "a cipher," and negative numbers "debts. (https://en.wikipedia.org/wiki/Negative_number)

But the concept of negative interest rates is rather bizarre and has rather turns heads upside down. Just imagine the exercise of estimating a present value as the discount rates goes further into negative….as the discount rate approaches and surpasses 100%, does that mean that the numerator cash flow being discounted has to also be negative to generate a positive net present value? After all, two negatives make a positive, right? Central banks may also be decimating their partners to running monetary policy i.e. commercial banks. Setting negative interest rates on deposits at central banks will eat into commercial banks’ interest rate revenues. Furthermore negative interest rates sharply flatten the yield curve which further compresses commercial banks’ interest

12

margins, preventing “gapping”. This is likely to become a double edge sword as it would thwart price discovery of credit creation and in it of itself drive the economies deeper into a deflationary spiral. Time will tell if credit actually expands or contract post the imposition of negative interest rates. Fig 12. USD/CNY bands widen � more volatility by

design Fig 13. A new USD-CNY hybrid note?

5.90

6.00

6.10

6.20

6.30

6.40

6.50

6.60

6.70

Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16

Mid-point USDCNY spot Trading band

Source: Bloomberg, CEIC, Reuters Eikon, KBank Source: www.cagle.com

Currencies and currency wars despite the denials are at play behind the scene. China’s move on its currency last summer stems from its attempt to decouple from the US dollar to become an international currency in its own right.

Fig 14. Rigid USD/CNY policy caused CNY NEER index

to track USD NEER index Fig 15. Rising CNY NEER index is a form of monetary

tightening, especially for Chinese SMEs

93.3

120.13

70

75

80

85

90

95

100

Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

115

116

117

118

119

120

121

122

123

124

125

Fed's USD trade weighted index, left KBank CNY NEER index, right

48.4

120.1

47.0

47.5

48.0

48.5

49.0

49.5

50.0

50.5

51.0

51.5

52.0

Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

105

107

109

111

113

115

117

119

121

123

125

CH Caixin PMI KBank CNY NEER index, right


China’s authority might have lingered too long by keeping USD/CNY too rigid for its own good. Having done so, the CNY on a trade weighted basis (NEER – Nominal Effective Exchange Rate) rose along with the US dollar NEER as well. Fig 14 shows our KBank calculated CNY NEER index versus the Fed’s US dollar NEER index. As the Fed ended the QE taper, it started to set expectations for higher Fed Funds via its “Dot Plots”. Since the summer of 2014, the rise in the US dollar NEER took the CNY NEER for a ride. This inadvertently is a form of monetary tightening for the Chinese economy causing the manufacturing sector to scale back.

13

Fig 16. PBOC USD/CNY adjustment causes JPY NEER to

strengthen Fig 17. BOJ QE remains in the financial sector only….

100.56

6.549

84

86

88

90

92

94

96

98

100

102

Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16

6.10

6.20

6.30

6.40

6.50

6.60

6.70

BOJ JPY NEER index, left USD/CNY, right

287

223

0

50

100

150

200

250

300

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

BOJ claims to govt (e.g. JGBs), JPY trn liabilities to financial institutions


Since China is about 22% of Japan’s total trade, the PBOC move to decouple / devalue its currency caused the JPY NEER to strengthen. Remember that currencies valuations are by and large….relative. We think that this is a major factor forcing the hand of the BOJ to move into negative interest rates. Furthermore, the BOJ’s so called QQE (Qualitative Quantitative Easing) isn’t really of effective quality after all. Fig 17 shows that as the BOJ buys more JGBs (Japanese Government Bonds), commercial banks just re-circulate the cash back to the BOJ, giving little tailwind to credit extensions. But to be fair to monetary policy makers, their tools may have met its match. Japan’s population peaked in 2008 at 127.8 million and has been declining, now at a rate of 14bps. In this case, supply will not create its own demand, i.e. a declining and aging population will also have falling marginal propensity to consume (MPC). Fig 18. Japan’s population had peaked in 2008 Fig 19. % of population over 65 years of age

127.8

80

85

90

95

100

105

110

115

120

125

130

50 54 58 62 66 70 74 78 82 86 90 94 98 02 06 10 14 18 22 26 30 34 38 42 46 50

JP population, mn est.

27.3

17.5 17.5

14.5

10.2

0

5

10

15

20

25

30

JN GB Euro US TH

population, % of over 65


For Thailand, many if not most economic agents are waiting for the completion of political reforms which would yield greater social / political / economic visibility. Until that environment is achieved, economic activity would be analogous to just treading water. Under these conditions, we view that monetary policy has to be accommodative but of this is no means a panacea. The interest rate channel is rather ineffective in our view. We would encourage a larger focus on currency accommodation given that the structure of the economy sees a tepid domestic demand / GDP. While our baseline forecast is for no move on the 1.5% policy rate, we are of the view that should the management of the baht be more reflective of a “free float” to the strengthening bias, rather than the intended “managed float” regime, the burden may have to fall back to the Monetary Policy Committee (MPC) to cut rates as a signal of its intentions of a weaker currency like last April.

14

Fig 20. Thai domestic demand vs. external demand to

GDP Fig 21. The two pillars of BOT monetary policy…interest

rates and exchange rates

91%

7%

88%89%90%91%92%93%94%95%96%97%98%99%100%

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

(C + G + I) / Y, left (X - M) / Y, right

113.2

110.4

107.5

90

95

100

105

110

115

09 10 11 12 13 14 15 16 17

1.001.25

1.501.752.00

2.252.50

2.753.003.25

3.503.75

KBank THB NEER, left BOT repo,% , right


15

What will prove to be a relief to the ailing Chinese

economy? � China has been on a path of ‘miraculous’ growth over the years

� By default, the miraculous growth cannot be sustain forever unless

there is continued innovation and technological advancement

� According to Solow Growth theory, three important sources of

growth come from labor productivity, investment or/and technology

� Labor productivity in China has been on a decline ever since wages

started to increase in the face of decelerating population growth

� Prospects for more gross capital formation is dimming, with the

Chinese government trying to curb further capital investment

� Investment in R&D has been stagnant, and significantly lagging

behind major economies

� Our assessment suggests that innovation is probably the best

solution to solve China’s productivity problem to provide relief to

the economy

� China is moving in the right direction, through its increased global

M&A deals as shortcut to acquire technological transfer. Yet, it

might be a while before technological advancement starts to

reflect in growth number

China through the looking glass In Greek Mythology, Atlas, as a punishment from Zeus, the king of Gods, is often described as the giant that carried the weight of the world on her shoulder. The Chinese economic reform of 1978 opened up Chinese borders to foreign trade; since then, the growth of the Chinese economy has been lauded as ‘miraculous’. At the peak of the global economy in 2007, China grew at 14.2%, while its annual GDP growth in 2015 came down to only 6.9%, missing the authority’s target of 7.0%. In fact, China has been carrying the weight of the world’s GDP on its shoulder, with China’s contribution to the world GDP increasing over the years to 20% (or one in five) in 2015. However, recent developments in the Chinese economy, such as the falling Renminbi (CNY) and stagnating inflation, have most of us worried. Will China be able to resume the ‘miraculous’ path of growth? Will China continue to be the giant to carry the weight of the world’s growth on their shoulders? As such, the following paper will look into some of the major issues currently facing the Chinese economy, in particular, its growth outlook and what will hinder and provide the relief for its growth prospects. China has been on a path of miraculous growth over the years. China’s growth trajectory has always been something of an outlier. A look at the figure below ascertains its significance in global economy, China’s GDP (based on purchasing power parity ( PPP) method) has surpassed that of the US economy since 2014. However, recent developments in the Chinese economy have some doubting the trajectory of its growth in

16

the coming years. The most alarming indicator has been the manufacturing Purchasing Managers’ Index (PMI), which has stayed below the level of 50pts since March 2015. Fig 22. China’s GDP based on PPP basis has exceeded

the U.S. since 2014

Fig 23. Labor productivity & gross capital formation in

China

0

5,000

10,000

15,000

20,000

25,000

1980 1985 1990 1995 2000 2005 2010 2015

0

20,000

40,000

60,000

80,000

100,000

120,000

China's GDP value US's GDP value World GDP, right

USD bn USD bn

0

2

4

6

8

10

12

14

16

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

38

40

42

44

46

48

50

Labour productivity growth Gross capital formation (as % of GDP), right

Source: IMF, KBank Source: World Bank, KBank

Limitations on China’s growth: Productivity, investment or technology? The Solow Growth theory states that developing econ omies tend to grow faster than developed economies, as returns for various fa ctors of production exhibit increasing rates of returns. In particular, capital (i.e. capital accumulation), labor productivity and technology are growing at an increasing rate. However, these increasing rates of return, by default, cannot be sustained forever, unless there is continued innovation and technological advancement. In order to get a clearer picture of these factors of production in China, the figure above depicts growth of labor productivity, gross capital formation and, while the figure below depicts investment in research and development. Fig 24. Average annual wage in China Fig 25. Investment in R&D (as % of GDP)

56,360

51,369

0

10,000

20,000

30,000

40,000

50,000

60,000

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Average annual wage for all sectors Average annual wage for maufacturing

CNY

1.23 1.32 1.38 1.38 1.46

1.68 1.73 1.791.93 2.01

0.0

0.5

1.0

1.5

2.0

2.5

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

China R&D (as % of GDP)

Source: CEIC, KBank Source: World Bank, KBank

The growth of labor productivity in China has been o n a decline since the last decade as can be seen from Fig 2. China initially grew at a tremendous rate by exploiting on its cheap labor cost. Yet, the period of cheap labor cost is fading away. As can be seen, the average annual wage for all sectors, as well as the manufacturing sector, has been on a sharp rise since the 90s. Since the 2000s, annual wage growth has averaged around 13% each year to CNY51,000 for annual wage in manufacturing sector (as of 2014). Another contributing factor to deteriorating productivity is its long-standing “one-child policy”. This policy has suppressed population growth and thus the number of new

17

workers entering the labor force. As a result, wages witnessed a rapid increase, and with declining number of new workers, productivity suffered a setback in the medium term, as well as long term. Fig 26. Comparative R&D investment

3.17 3.14 3.133.31 3.41 3.46 3.47 3.36 3.25 3.38 3.34 3.47

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

China USA Japan

R&D (as % of GDP)

Source: World Bank, KBank

The second factor, investment, denoted by the gross capital formation rate as a % of GDP, witnessed an increase in the initial years of the past decade. Prior 2008, the figure averaged to only 42% during 2005-2007, compared to 45% of the GDP post 2009. Following extensive capital investment during the Beijing Olympics, coupled with the government’s CNY4trn massive stimulus package in late 2008, the Chinese economy had started to show signs of overheating. The Chinese government, fearing that an investment bubble was underway, decided to curb such investments and announced in 2014, that economic rebalancing was at the forefront of its agenda. With the aim of reducing investment as a share of GDP and decreasing the reliance of the domestic economy on external factors, the Chinese government attempted to push for higher consumption. Therefore, with the shift in the structural policy being discretionary to avert bubble crash and hard-landing scenario, the persistent soft-landing growth is likely to persist. Lastly, for the case of technology advancement, res earch and development as a % of GDP has been more or less stable over the last t en years. Recent data from the World Bank shows that R&D expenditure in China accounts for only 2% of GDP in 2015. In comparing technology investment by China with other countries, such as the United States and Japan, it can be seen that for the past decade, China has lagged behind in terms of technological investment. However, on a more positive note, according to the Asian Development Bank, high technology exports- such as aerospace, high-speed railways, and nuclear technology- increased from a mere 9.4% in 2000, to 43.7% in 2014 in Asia. However, China’s high technology exports still lag behind in the western market; thus, showcasing that there is still scope for further innovation in China. In sum, given China’s agenda to curb capital format ion and population, technology advancement looks like the most promising way to ke ep the country’s growth afloat. In fact, in the past China has been resorting to merger and acquisitions in order to acquire cutting-edge technology, somewhat representing a shortcut for innovation growth for the country. Some examples of recent high worth merger and acquisition deals can be found in the table below.

18

Fig 27. Recent high net M&A activity in China Sector Detail Value

Technology Chinese firm, HC International, acquired the entire share capital of Orange Triangle, a provider of internet portals services.

USD 240 million

Electric Appliances Johnson Controls of the US agreed to acquire 60% of the global air conditioner business of Chinese Hitachi Appliances.

USD 590 million

Service Dalian Wanda Group of China acquired the entire share capital of World Triathlon Corp, a Tampa-based provider of triathlon services.

USD 650 million

Service Delta Air Lines of the US agreed to acquire a 3.676 percent stake in China Eastern Airlines Corp, a Beijing-based passenger airline company.

USD 450 million

Source: KBank’s compilation from the Press

Technology may provide some relief for the economy To conclude, while there are other factors that may be thwarting China’s growth, total productivity has also proved to be a major impediment. Given China’s stance on curbing its capital formation and population, technological innovation could be the most promising factor of production for China’s growth potential. Essentially, given that theory suggests that an economy may only achieve further growth through continuous innovation, increased technological investment may be China’s way of being the Atlas of the world’s GDP growth. It seems like China has already been moving in the right direction, through its increased global M&A deals. However, it might be a while before technological advancement through M&A and investment in R&D, starts to reflect in China’s overall economic growth.

19

The ECB’s Second Chance: Will Draghi fuel risky rallies?

� In December, the ECB’s Governing Council (GC) disappointed

markets greatly when it failed to raise the size of its asset

purchase program

� However, recent rhetoric from Eurozone’s policymakers, the ECB’s

President, and the GC’s January meeting minutes have ignited

investors’ animal spirit

� The GC meeting minutes show that the ECB’s main concerns are

not in underlying economic indicators, but on deflationary pressure

� However, we view that the economic backdrop has deteriorated

since December, and could add further pressure to the GC

� Despite external weakness, the Eurozone’s domestic demand,

which is the Eurozone’s major economic driver over the past years,

is likely to decelerate going forward

� The ECB cannot afford to let the economy decelerates and feed

into a deflation spiral

� The decline in Brent oil price since the December meeting has

caused inflation expectations to drop as much as 0.3%pt

� The market cautiously embraces biases for further ECB easing on

March 10th

� Removing the capital key limit on the APP program will allow the

ECB to buy higher amount of peripheral bonds, and extend the APP

program beyond March 2017

� Investors seem to position cautiously for that, given the glaring

disappointment at the December meeting

� With the BoJ’s easing policy and the Eurozone’s high exposure to

emerging markets, the pressure, and the stake, for the ECB to

deliver up to and above expectations is raised higher

� Against this backdrop, we see further downside for EUR/USD, and

expect the pair to end Q2/16 at 1.055

The Bank of Japan (BoJ) took financial markets by surprise when it decided to lower its policy rates below zero for the first time in history, raising the bar for other central banks to up the ante on their monetary policy easing. Looking at inflation developments among developed countries, we believe “the great divergence” theme is genuine and will remain a critical driving factor behind FX and interest rate development throughout this year. With the Eurozone’s February headline inflation print dropping back into deflation (-0.2%YoY), markets are anticipating additional stimulus from the European Central Bank

20

(ECB) on March 10th. Will the ECB deliver up to expectations or will it deter the ongoing bear market rallies? We analyze Eurozone’s economic and inflation developments, and the impact of additional easing f rom the ECB.

What has changed since December?

In December, the ECB’s Governing Council (GC) disap pointed markets greatly when it failed to raise the size of its asset purch ase program (APP). During that meeting, the GC (1) cut the deposit rate by 10bps to -0.3% (other rates unchanged); (2) extend APP by six months; and (3) add regional and local government bonds into the APP. The GC also announced two housekeeping measures that (1) it will reinvest proceeds on assets bought for as long as necessary, and (2) it will extend unlimited liquidity for refinancing operations at least until 2017. Market reaction was underwhelming at best, reflecting the investors’ “buy on rumor, sell on fact” behavior. The EONIA rates had priced in a 15bps rate cut in the run-up to the announcement. EUR/USD reversed its downward trend abruptly to peak at 1.1375. Previously, the pair had declined to 1.05, which is the trough last seen in April 2015. However, recent rhetoric from Eurozone’s policymake rs, the ECB’s President - Mr. Draghi, and the GC’s January meeting minutes have i gnited investors’ animal spirit. In January, Mr. Draghi said the ECB would “review and possibly reconsider” its monetary policy stance at its next meeting in March. January meeting minutes showed that members have become more unanimous in their assessment of risks, and showed less resistance to easing. Mr Draghi had wide support from the GC to get ahead of the deflation threat. One member even said the central bank should consider “a limited period of overshooting” the inflation target — after three years of undershooting — to show the ECB is serious about fulfilling its price stability mandate. The fear of a feed-through to wages has become more prominent among the GC. Notably, most members agreed that the risks for the Eurozone economy had risen since the December meeting, due to emerging markets’ (EM) weakness and heightened financial and commodity market volatility. This was the first time that the GC voiced concerns on financial market development in complementary to deflationary pressure. Below, we list the GC’s point of views to judge the ECB’s next move.

Factors 3rd December 2015 meeting 21st January 2016 meeting

Decision To lower the interest r ate on the deposit facility by 10 basis points to -0.30%. The interest rate on the main refinancing operations and the rate on the marginal lending facility will remain unchanged at their current levels of 0.05% and 0.30% respectively. To extend the monthly purchases of €60 billion under the APP until the end of March 2017, or beyond. To reinvest the principal payments on the securities purchased under the APP as they mature, for as long as necessary. To include euro-denominated marketable debt instruments issued by regional and local governments in the list of eligible assets.

Unchanged

Economic development

Real GDP increased by 0.3%QoQ in Q3/15 , following a 0.4% rise in Q2/15, on consumption growth alongside more muted developments in investment and exports.

The most recent survey indicators point to ongoing real GDP growth momentum in Q4/15. Looking ahead, we expect the economic recovery to proceed.

21

Inflation development

Annual HICP inflation was 0.1% in November 2015, unchanged from October, but lower than expected . Annual HICP inflation rates are expected to rise at the turn of the year, on the fall in oil prices in late 2014.

The December CPI was lower than expected , reflecting the renewed sharp decline in oil prices, and lower food price and services price inflation. Current oil futures prices, which are well below the level observed a few weeks ago , the expected path of annual inflation in 2016 is significantly lower compared with the outlook in early December.

Financial development

M3 growth rose 5.3 % in October 2015 from 4.9% in September. Loans to non-financial corporations increased to 0.6% in October, up from 0.1% in September. Developments in loans to enterprises continue to reflect the lagged relationship with the business cycle, credit risk and the ongoing adjustment of financial and non-financial sector balance sheets. The monetary policy measures in place since June 2014 have clearly improved borrowing conditions .

M3 growth rose 5.1% in November 2015 from 5.3% in October. Loan dynamics continued the path of gradual recovery observed since the beginning of 2014. Developments in loans to enterprises continue to reflect the lagged relationship with the business cycle, credit risk and the ongoing adjustment of financial and non-financial sector balance sheets. The bank lending survey for Q4/15 points to further improvements in demand for bank loans, supported by the low level of interest rates, financing needs for investment purposes and housing market prospects.

Staff economic projections

GDP is expected to grow 1.5% in 2015, 1.7% in 2016 and 1.9% in 2017. HICP inflation is seen at 0.1% in 2015, 1.0% in 2016 and 1.6% in 2017.

n.a.

Risk to growth The risks to growth outlook relate to heightened uncertainties regarding developments in the global economy and to broader geopolitical risks.

The risks to growth outlook remain on the downside, relating to heightened uncertainties regarding developments in the global

Risk to inflation During 2016 and 2017, inflation rates are foreseen to pick up further , supported by our previous monetary policy measures.

Inflation rates should continue to recover, but risks of second-round effects should be monitored closely.

Other risk factors

The economic recovery continues to be dampened by subdued growth prospects in emerging markets and moderate global trade, the necessary balance sheet adjustments in a number of sectors and the sluggish pace of implementation of structural reforms.

Downside risks have increased again amid heightened uncertainty about emerging market economies’ growth prospects, volatility in financial and commodity markets, and geopolitical risks. In this environment, euro area inflation dynamics also continue to be weaker than expected. It will therefore be necessary to review and possibly reconsider our monetary policy stance at our next meeting in early March.

Source: ECB, KBank’s compilation

The January meeting minutes show that the ECB’s mai n concerns are not in underlying economic indicators, but on deflationary pressure. However, we view that the economic backdrop has deteriorated since D ecember, and could add further pressure to the GC. Since January, global PMI data suggests that the global economy started 2016 on a weak footing. Production activities decelerated across the board, especially in China and the US. Meanwhile, similar picture also occurs in the Eurozone as production activities in major countries, i.e. Germany and France, have decelerated sharply since January. Even though service sector contributes to over 80% of the Eurozone’s economy, manufacturing sector remains an important growth driver; the relationship between industrial production and GDP growth is as high as 78% (R-squared). The weakness abroad has been a major factor weighing on the Eurozone’s

22

GDP since Q3/15. The rise in the euro is also putting pressure on the Eurozone’s trade competitiveness which is one of the ECB’s main transmission channels, while emerging market (EM) currencies have been gaining competitiveness amidst risk-off trades since the beginning of the year. Based on the Eurozone’s trade structure, the Eurozone is highly sensitive to currency wars in EM as almost half of its trade is exposed EM. In fact, all major product groups of Eurozone’s exports have performed poorly since H2/15, due to contraction in exports to commodity-exporters and Asia, thus, reiterating the importance of keeping EUR weak.

Fig 28. Major countries’ PMI index suggests the global

economy started 2016 on a weak footing

Fig 29. The Eurozone’s economy is highly dependent on

manufacturing sector, thus, EUR competitiveness is

vital

49

52.3

50.2 50.551.2

49.5

46

47

48

49

50

51

52

53

54

55

China (official) Japan France Germany Eurozone U.S.(ISM)

Oct-15 Nov-15 Dec-15 Jan-16 Feb-16

Index (Neutral=50)

-7.5-6.5-5.5-4.5-3.5-2.5-1.5-0.50.51.52.53.54.5

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-20

-15

-10

-5

0

5

10

GDP, left Industrial production, right

%YoY %YoY

Source: CEIC, KBank Source: CEIC, KBank

Fig 30. Exports have been a major drag on the

Eurozone’s recovery

Fig 31. The Eurozone’s exposure to EM is high in terms

of currency and trade competitiveness

-0.2-0.3

-0.1

-0.4-0.2

0.40.2 0.2 0.2

0.1

0.3 0.40.5

0.40.3

-1.00

-0.75

-0.50

-0.25

0.00

0.25

0.50

0.75

1.00

1.25

1.50

1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15

Imports

Exports

Inventories

Investment

General

consumption

Private

consumption

GDP

%QoQ

1 1 1 1 1 1 2 2 2 2 2 2 3 3 3 35 5

6 6

11

1213

0

2

4

6

8

10

12

14

Singa

pore

Algeria

Can

ada

UAE

Mexico

Sau

di Arabia

Brazil

India

Rom

ania

Norway

S.Korea

Den

mark

Japa

n

Hun

gary

Turkey

Swed

en

Russia

Czech

Swiss

Polan

d

China UK

US

% exposure


Despite external weakness, the Eurozone’s domestic demand, the Eurozone’s major economic driver, is likely to decelerate goin g forward. The latest survey of service providers shows demand for services has declined steadily since December, while employment sub-index surprisingly dropped for the first time in three months in February. This suggests the Eurozone’s services sector cannot decouple from the slowdown in manufacturing sector and external development. Although it is unclear the direction of causality, the downside surprise in the Eurozone’s economic data will negative affect investor inflation expectations. On the credit front, more stringent regulations and weak balance sheet remain prominent obstacles to the functioning of financial intermediaries. Shares of European banks are still trading at prices well-below their book value, reflecting that markets are expecting additional recapitalization. Senior loan survey also reiterates the fact the higher risk collateral demand has become an important obstacle to lending to enterprises as opposed to economic outlook as seen in 2015.

23

Fig 32. Survey of service providers point to worsening

economic outlook

Fig 33. Banks cited higher risk collateral demand as an

important challenge against lending

0

5

10

15

20

Service Confidence demand outlook employment outlook

Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16

Index

75

80

85

90

95

100

Funding

cost

Access to

Market

Liquidity Competition

from Banks

Competition

from Non

Banks

Competition

from Market

Economy Industry Collateral

Demanded

Jan-14 Jan-15 Jan-16

%


The ECB cannot afford let the economy deteriorates and feed into a deflation spiral. Eurozone’s consumer price index depends almost equally on goods and services prices: goods weighting is 56% and services weighting is 44%. Goods prices are dependent on oil price and EUR exchange rate vs trading partners. In fact, goods prices have been the major drag on the Eurozone’s inflation. Stripping of energy costs, we found that the euro exchange rate against currencies of Eurozone’s trading partners, represented by EUR nominal effective exchange rate (EUR NEER), helps dictate prices of goods sold in the Eurozone. Thus, the strength in the euro dampens price pressure, and feed through to deflation risk. On the other hand, services inflation, holds as much as 44% share in the Europeans’ consumption basket, and are largely influenced by wage growth (47% relationship). Since 2013, wage growth and services CPI have been declining steadily, as unit labor costs across Eurozone countries converge and standards of living lower as a result of the debt crisis. Meanwhile, slower economic growth means the output gap will remain open longer. The IMF estimated that the Eurozone’s output gap will remain negative by 2.25% of GDP throughout 2016, suggesting that wage growth still has large room to accelerate before inflation picks up. Fig 34. The Eurozone’s disinflationary pressure is driven

by goods prices

Fig 35. Contribution to the Eurozone’s CPI

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

10 11 12 13 14 15 16

Headline CPI (HICP) Goods Services

%YoY

-1.00

-0.75

-0.50

-0.25

0.00

0.25

0.50

0.75

1.00

Jan-15

Feb

-15

Mar-15

Apr-15

May-15

Jun-15

Jul-1

5

Aug

-15

Sep

-15

Oct-15

Nov-15

Dec-15

Jan-16

Goods Serv ices HICP inflation

%YoY


24

Fig 36. Contribution to the Eurozone’s CPI Fig 37. The Eurozone’s goods CPI is driven by EUR

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Jan-15

Feb

-15

Mar-15

Apr-15

May-15

Jun-15

Jul-1

5

Aug

-15

Sep

-15

Oct-15

Nov-15

Dec-15

Jan-16

Others

Misc.

Tourism

Recreation

Transport

Home furnishings

Utilities

Food

HICP inflation

%YoY

90

95

100

105

110

115

120

04 05 06 07 08 09 10 11 12 13 14 15 16

-0.5

0.0

0.5

1.0

1.5

2.0

EUR NEER, left Non-energy industrial goods CPI (lagged 2Y), right

Index (1999=100) %YoY


The decline in Brent oil price since December has c aused inflation expectations to drop as much as 0.3%pt, as shown by the 5Y5Y breake ven inflation swap rates which represents investors’ view on 5-year inflatio n 5-years from now. Inflation expectations further diverged from the 10-year average (2.24%) towards the weakest levels on record at 1.38% in 2016. The pessimism on inflation outlook is not confined only within investors and professional forecasters, but also among consumers. We expect the ECB to revise down its inflation forecast from 1.0% and 1.6% in 2016 and 2017 to account for lower oil price since the ECB staff projection assumed that oil price would be at 52.2 and 57.5 USD/brl, respectively. Thus, the ECB needs to step in to stimulate services activities and stave off deflationary pressure as global economic momentum remains sluggish. Fig 38. The Eurozone’s service CPI is driven by wage

growth

Fig 39. Oil price drives the Eurozone’s inflation

expectations

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Negotiated wage Service CPI

%YoY

Correlation = 47%

25

30

35

40

45

50

55

60

65

70

Jan-15 Apr-15 Jul-15 Oct-15 Jan-16

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

ECB Dec-15 meeting Brent crude price EUR 5y5y breakeven inflation (right)

USD/brl %


The market cautiously embraces the bias for further ECB easing on March 10 th. The issue is how the market would respond to that. Japan set a dangerous template for global market risk. Policies based on deeper negative rates have not been rewarded by the market with relief in sentiment. Quite the opposite, it raises questions regarding the sustainability of the financial sector. That leaves the ECB with limited alternatives as to how to increase its easing efforts. Expected policy measures include a deposit rate cut, an increase in monthly asset purchase, and an extension of the APP program. Based on Eurozone’s OIS rates, the market gives a 92% probability that the ECB will cut rates by 10bps (0.10%) to -0.40% in March, while some expect a second cut in August by another 10bps. Additionally, the ECB is expected to raise its monthly asset purchases by EUR 10bn to EUR 70bn/month, and an extension of the APP program beyond March 2017 to September-December 2017. Lastly, the ECB is also likely to announce downward revisions to CPI and GDP forecasts, which would probably lead to broader consensus

25

among governing council members for more easing. Broad consensus shows that investors feel that the ECB has not yet reached its APP limit.

Apart from the APP, the ECB should remove the capit al key limit on the program to allow itself to buy higher amount of peripheral bon ds, and extend the APP program beyond March 2017. Since the beginning of the year, peripheral countries’ yield spreads to German bond yields have risen broadly, reflecting higher risk premium in investors’ view, despite the risk-on rallies that support risky assets at the moment. We think the prevailing bear market rallies. Thus, this shows that financial conditions in peripheral countries have tightened. Spain, for instance, has more than EUR 140bn of bonds maturing this year. A lower cost of refinancing will alleviate the government’s budget deficits. Stimulating nations' economies isn't the only inflation benefit from expanding APP as the move could also weaken EUR, which could raise the cost of imports and give another boost to inflation. Local media cited that German local and regional outstanding debt totals EUR 250-300bn. Thus, as the ECB buys EUR 11-12bn of German bonds each month. In January, the ECB has bought a cumulative EUR 128bn of German bonds; thus, the ECB can extend its purchase for 2-3 quarters to Q1/18. However, if the ECB raises the monthly purchases to EUR70bn, this will fasten the deadline to Q4/17 unless the ECB eliminates the capital key limits.

Fig 40. Peripheral bond 10-year yield spreads vs

German Bund 10-year yields

Fig 41. Capital key limits on peripheral bond buying

constrains APP impact

2.001.16 1.24

9.38

2.84

1.23 1.32

9.32

0

1

2

3

4

5

6

7

8

9

10

Portugal Italy Spain Greece (right)

%

Over the past 12M Current

25.6

20.117.5

12.6

5.73.5 2.8 2.5 1.8 1.6 1.1 0.5

4.7

0

5

10

15

20

25

30

Germ

any

France

Italy

Spa

in

Netherland

s

Belgium

Austria

Portuga

l

Finland

Irelan

d

Slovakia

Slovenia

Others

Capital key (%)


Investors seem to position cautiously for that, giv en the glaring disappointment at the December meeting . The ECB has eased four times over the past two years, but the impact on the euro varied each time. The euro continued to move lower when the market expected additional easing would follow; however, the Dec-15 meeting trailed market expectations as the euro reversed its downward trend to trade sideways following the meeting. In the same fashion, the market added short-EUR positions ahead and after the first three policy changes. But, they turned to reduce EUR-short positions after the December meeting. This time round, the market is going into the ECB meeting with light short-EUR positioning, about 68,000 contracts - a third compared to the previous three policy changes (on-average 164,000 short-positions).

26

Fig 42. Impact of the ECB’s previous easing attempts

3M 1M 1W 1D ECB 1D 1W 1M 3M 3M 1M 1W ECB 1W 1M 3M

1.39 1.39 1.36 1.36 1.37 1.36 1.36 1.36 1.29 24 33 -16 -33 -57 -61 -161

1.5 1.6 -0.2 -0.4 - -0.1 -0.6 -0.5 -5.6 57 66 17 - -24 -28 -128

1.36 1.34 1.32 1.32 1.29 1.30 1.29 1.25 1.24 -33 -128 -150 -161 -157 -146 -159

5.1 3.7 1.7 1.6 - 0.1 -0.1 -3.3 -4.4 128 33 11 - 4 15 2

1.26 1.22 1.18 1.16 1.14 1.12 1.13 1.13 1.10 -159 -147 -167 -180 -184 -177 -215

11.3 7.6 3.6 2.1 - -1.4 -0.4 -0.3 -3.1 21 33 13 - -4 3 -35

1.11 1.10 1.06 1.06 1.09 1.09 1.10 1.08 1.10 -68 -134 -175 -182 -172 -160 -68

1.7 0.2 -2.7 -3.0 - -0.5 0.5 -1.0 0.2 114 48 7 - 10 22 -

4.9 3.3 0.6 0.1 -0.5 -0.2 -1.3 -3.2 80 45 12 -4 3 -54

1.5 0.2 -2.7 -3.0 -1.4 -0.6 -3.3 -5.6 21 33 7 -24 -28 -128

11.3 7.6 3.6 2.1 0.1 0.5 -0.3 0.2 128 66 17 10 22 2

3-Dec-15

Average movement

Min

Max

Impact on EUR net long positions

Move to negative rates: main refinancing operations to 0.15% (-10bps), marginal lending facility to 0.40% (-35bps), deposit facility to -0.10% (-10bps).

Impact on EUR/USDDate Measures

5-Jun-14

4-Sep-14

Move further to negative rates: main refinancing operations to 0.05% (-10bps), marginal lending facility to 0.30% (-10bps), deposit facility to -0.20% (-10bps).

Announced asset purchase program (APP) to buy Eurozone govt bonds by EUR 60bn per month until Sep-16.

22-Jan-15

Lowered deposit rate to -0.30% (-10bps); include regional and municipal bonds to APP; extend APP to Mar-17

Source: Bloomberg, KBank

Fig 43. IMM futures positioning data suggests investors

are less optimistic that the ECB will deliver up to

expectations (negative = short EUR)

Fig 44. The relationship between the euro and oil price

is as high as 90%

-500

-400

-300

-200

-100

0

100

Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16ECB easing EUR-positioning

'000 contracts (2-week moving average)

20

30

40

50

60

70

80

90

100

110

120

Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16

1.00

1.05

1.10

1.15

1.20

1.25

1.30

1.35

1.40

Brent oil price, left EUR/USD, right


With the BoJ’s easing policy and the Eurozone’s hig h exposure to emerging markets, the pressure, and the stake, for the ECB t o deliver up to and above expectations is raised higher . We think the euro has remaining downside from the current 1.10 level. The market median estimate of analysts surveyed by Bloomberg sees EUR/USD dropping to 1.07 per dollar by the end of Q2/16 and 1.08 by year-end 2016; a fifth of forecasters looking for a drop to parity with the dollar for the first time since 2002. The average EUR/USD movement over the past three ECB moves suggests that EUR/USD can lower by 3.0% in three months following past policy announcements. Another three important factors that must be taken into account are (1) the Fed’s second rate hike in June, (2) possible rise in oil price, and (3) further easing from the ECB. From December’s history, the euro weakened by 1.0% following the Fed’s rate hike. We think the weakness was due to USD strength rather than demand to lower EUR-short positioning since the amount of EUR-shorts barely changed. Therefore, the movement can be attributed to adjustment for larger interest rate spread between EUR and USD. On the other hand, oil price plays an even more significant role on the euro via inflation

27

expectations compared to the Fed’s policy outlook. The relationship between the euro and oil price is as high as 90%, while that with the Fed’s policy outlook is only 70%. On the last factor, some market players are expecting one additional cut (to -0.5%) from the ECB in 2016. The above factors all point to further EUR/USD do wnside. As such, we expect the pair to end Q2/16 at 1.055.

The disconnection between local and foreign bond flows

� The theme on global monetary easing has been revived after the

BOJ’s negative rate adoption in the beginning of 2016

� The distorted interest rate places limit on the universe of investible

assets, pushing more money out for better returns elsewhere

� Another important development from Japanese market is the shift

in asset allocation of the biggest pension fund. The fund is now

targeting 40% allocation in foreign assets compared to 23%

previously

� The real winner from Japanese money flood seems to be the U.S.

markets. Inflows to both fixed income and equities outperform the

rest of the world

� The key implication is on the pace of Treasury yield rise which

should be quite inert despite the continuation of Fed fund rate

normalization

� Looking from Thailand’s perspective, Japanese inflows to bond

markets has persistently outperformed that of stocks and it is

likely to continue

� There has been the disconnection between local and foreign bond

flows; market resilience has been mainly supported by domestic

investors

� We shift the priority of the most influential factor for fixed income

market from Fed fund rate normalization to existing onshore

liquidity following strong onshore demand, likely to keep yield at

subdued level

� Other supporting factors for the market are 1) lighter traffic from

BOT, SOE and corporate bonds 2) excess liquidity from large banks

and 3) cost of going offshore is not attractive

� Despite more supporting factors, we are cautious about the market

direction. Thai bonds are excessively rich especially when

comparing to UST yield; this makes our case why we do not expect

further rally to persist

28

Hunting for yields resumed

The theme on global monetary easing was revived again after the BOJ unexpectedly adopt negative interest rate earlier this year. The pressure is now on the ECB who is taking care of fragile economic bloc and is pressured by the markets to join ‘aggressive monetary easing’ club. The turnaround of Japan’s monetary policy came in April 2013 when the Bank of Japan (BOJ) implemented its aggressive QE program, formed as one of the three branches under Abenomics. From then, a lot has changed in terms of Japanese’s monetary policy landscape with the country has earlier this year adopted negative interest rate to fight the battle of persistent deflationary pressure. While the BOJ suggested that a negative rate will have limited impact on banks’ earnings, the distorted interest rate is likely to place a limit on the universe of investible assets for cash-rich Japan and thus pushes more money to flee the country, creating the winners and losers for this game.

In addition to aggressive monetary policy, another important development seen is the shift in asset allocation for the Government Pension Investment Fund (GPIF) – the biggest pension fund in Japan – since October 2014. The fund is now targeting a much bigger portion to foreign assets (from 23% in total foreign assets to 40% of investment) with the attempt to enhance returns away from domestically low yield. In fact, the most updated GPIF performance (as of 4Q15) suggested that the reallocation of asset is still ongoing (with only about 36.32% allocating to foreign assets) and thus should support for continued strong appetite in foreign investment.

Fig 45. Change in asset allocation of the biggest Japanese pension fund

Asset classes Old target allocation

Possible deviation

New target allocation (Oct 2014)

Possible deviation

Asset allocation (End 2014)

Asset allocation (Dec 2015)

Japanese bonds 60% ±8% 35% ±10% 39.39% 37.76%

Japanese stocks 12% ±6% 25% ±9% 22.00% 23.35%

Foreign bonds 11% ±5% 15% ±4% 12.63% 13.50%

Foreign stocks 12% ±5% 25% ±8% 20.89% 22.82%

Short-term assets 5% 5.08% 2.57%

Total assets (in JPY bn) 143,951 139,825

Source: GPIF, KBank

Where does money flow? Winners and losers from BOJ’s negative

interest rate

This paper examines the past and hopefully forecasts the behavior of Japanese’s outward portfolio investment. As the BOJ affirms its commitment in prolonged monetary policy easing even after the adoption of negative interest rate, the prospects of further rate cut into deeper negative territory cannot yet be ruled out.

29

Fig 46. Japanese foreign assets investment Fig 47. Growth in bond and stock investment

-10,000

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

07 08 09 10 11 12 13 14 15 16

Japanese investment in foreign bonds Japanese investment in foreign stocks

JPY bn

13.2%

32.3%

-3.6%

0.8%17.0%

4.6%4.2%

-17.5%

-64.8%

116.5%

184.2%

10.1%

-100%

-50%

0%

50%

100%

150%

200%

2011 2012 2013 2014 2015 2016

Growth of foreign bond investment Growth of foreign equities investment

Source: Bloomberg, Japan’s Finance Ministry, KBank

Note: The data is on a bi-weekly basis and the latest available is as of February 26, 2016. The graph is calculated as the accumulation of purchase from 2007 onwards without the adjustment of price gains.


Note: The data is on a bi-weekly basis and the latest available is as of February 26, 2016. The growth rate is calculated based on growth of the accumulation of purchase from 2007 onwards without the adjustment of price gains.

Historical data on Japan’s foreign portfolio investment suggested outward investment has long been observed even before Japanese-style QE in April 2013. The advocating factor is of course Japanese’ low returns. It should be noted that most foreign investment is allocated to global bond market rather than stock ones (with 80:20 ratio). Yet, the recent move suggests that there is a reason to believe that foreign stock investment may outperform bond’s in 2016. One of the key reasons was the recent shift in global monetary policy which pressed 1 in 5 of developed market’s sovereign bonds to yield negative returns; such scenario left yield-seeking investors with limited choice but to increase the exposure to riskier assets i.e. equities to gain desired returns. Japanese investors are not the exception; the data suggested that equities investment growth outpaced that of bond during 2014-2015 and so far in 2016. Growth in foreign stock investment recorded 184% in 2015 compared to 17% growth in bond investment. In addition, for YTD2016 (as of February 26th, 2016), foreign stock investment growth is recording 10.1% from the previous year-end, compared to 4.6% growth seen in foreign bonds.

Fig 48. Japanese investment in foreign bonds in 2015 Fig 49. Japanese investment in foreign stocks in 2015

U.S.

41.9%

Europe

21.0%

Central & South

America

23.4%

Asia

4.6%

ROW

9.1%

U.S.

17%

Europe

17%

Central & South

America

55%

ROW

6%

Asia

5%


Note: The data is on a monthly basis and the latest available is as of December 2015. The graph is calculated as the accumulation of purchase from 2007 onwards without the adjustment of price gains.


Note: The data is on a monthly basis and the latest available is as of December 2015. The graph is calculated as the accumulation of purchase from 2007 onwards without the adjustment of price gains.

Looking closer to investment in Thai market, the picture seems to be less encouraging. Most foreign investment in equities from Japan has diverted to developed markets including U.S. and Europe (account for 17.4% and 17.2%) whereas Asia’s share accounts for 13.7% of total net investment at the end of 2015. In Asia, Thailand seems to

30

be the only market which has seen continued reduction in net inflows during 2015; net investment dropped by 38.6%. Other markets like South Korea and Singapore, and other ASEAN economies (excluding Thailand, Malaysia and Singapore) still manage to enjoy inflows during 2015. In regard of stock markets, Japanese investors seem to be very sensitive to Thai political stability; the graph suggested a large sell-off in Thailand since late 2013 when instability heightened the risk for investment. The current position reflected that the Japanese investors still slightly underweighted Thai stocks (at JPY12.7bn compared to the average long-term position of around JPY24bn since 2007). We think one connotation here is that there seems to be a potential upside from Japanese inflows for Thai market once national election is held and domestic recovery is on a clearer path.

Fig 50. Stock investment in Asia Fig 51. Stock investment in Thailand

-600

-400

-200

0

200

400

600

800

07 08 09 10 11 12 13 14 15

China Thailand Malaysia

South Korea Singapore Other ASEAN

JPY bn

-40

-30

-20

-10

0

10

20

30

40

50

60

07 08 09 10 11 12 13 14 15

Thailand Average position in Thai stocks since 2007

JPY bn

Source: Bloomberg, Japan’s Finance Ministry, KBank Source: Bloomberg, Japan’s Finance Ministry, KBank

From fixed income side, the picture seems brighter. Even though Thai equities saw no inflows to stock, fixed income market received very comparable inflows to other Japan’s Asian favorites. In 2015, inflows to Thai bonds by the Japanese recorded JPY73.3bn, compared to other markets including South Korea and Malaysia of JPY86.7bn and JPY88.0bn. In fact, the pace of growth actually showed a better record; growth of Japanese inflows in 2015 was 21.1% from the previous year compared to Malaysia’s 19.5% increase and South Korea’s 7.1% growth.

Fig 52. Bond investment in Asia Fig 53. Bond investment in Thailand

-200

0

200

400

600

800

1,000

1,200

1,400

1,600

07 08 09 10 11 12 13 14 15

China Thailand Malaysia

South Korea Singapore Other ASEAN

JPY bn

-100

0

100

200

300

400

500

07 08 09 10 11 12 13 14 15

Thailand

JPY bn

Source: Bloomberg, Japan’s Finance Ministry, KBank Source: Bloomberg, Japan’s Finance Ministry, KBank

Despite that Asian assets have more or less benefit ed from past year’s Japanese money-printing, the real winner here seems to be th e U.S. Inflows to both fixed income and equities outperform the rest of the world and the share of inflows has been

31

increasing. In terms of value, U.S. market accounts for 42% of Japan’s foreign bond investment and accounts for 17% in stock investment (as of 2015). Growth pace was also impressive with 58% increase in inflows to bond and 247% increase in equities last year. This goes to show that the U.S. remains the brightest spot in the global economy amidst the dim light from the rest of the world. The key implication here suggest that the pace of Treasury yield rise should be quite inert as interest rate is likely to be capped at rather low level compared to historical standpoint, following strong appetite for U.S. assets. This should also support interest rate to stay low globally with no push coming from long-term Treasury yield.

The disconnection between local and foreign bond flows

Despite the possibility of fresh money from new round of global easing that could be coming from non-U.S. sources, more positive factors can actually be found from the domestic market itself. Strong demand from local investors has been the main attributors to the strong performance since the beginning of this year. In fact, we shift the priority of the most influential factor for fixed income market from Fed fund rate normalization to existing onshore liquidity. The following reasons lead us to believe that the demand from onshore fixed income investment would remain resilient and yield could be remain at the lower bound compared to historical standard:

1) The traffic of corporate bond issuance should be lighter while supply from public sector has been fully priced-in

Interest cost saving theme seen during 2014 and 2015 should largely wane off as global market environment is now calling for low yield for longer amidst monetary easing. At the same time, corporate spread for high credit bonds also remained at low level, putting issuers at ease about rapid rising cost of funding.

Fig 54. Corporate bond issuance Fig 55. Corporate bond spread remained at low level

274.922314.063

417.687 421.984

263.19

0

50

100

150

200

250

300

350

400

450

2012 2013 2014 2015 2M2016

(annualized)

Non-financial corporate bond issuance with maturity longer than 1 year

THB bn

20

40

60

80

100

120

140

160

180

Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

AAA, >5 Yr AA, >5 Yr A, >5 Yr

bps

Source: ThaiBMA, KBank Source: CEIC, ThaiBMA, KBank

Data on corporate issuance for the first 2 months of 2016 suggested that issuance has been quite in line with the previous years. Despite such dynamics, we will be closely watching on the traffic during each March and April which is usually the ‘high season’ for issuance. We believe that the issuance should either be flat or seeing slightly lower volume compared to 2015.

Indicators from domestic investment also confirm light traffic. Even though private investment index (PII) suggested that investment has crept up at the end of 2015, we think this mostly reflects business spending on cars to take advantage of the excise tax hike in January 2016. We expect PII to become softer in the coming months as the impact of the tax hike should be only a time-shift for car

32

purchase. In fact, there has been discrepancy between investment and capacity utilization rate which remained low (currently at 63-64%). We side more with the signal from capacity utilization and believe that there is no urgency for business to expand investment at this stage.

Fig 56. There has been discrepancy between

investment and capacity utilization rate

Fig 57. Public borrowing via bond issuance

95

100

105

110

115

120

125

130

11 12 13 14 15 16

%

45

50

55

60

65

70

75

80

Private investment index Capacity utilization, 3m average, right

Index (2011=100)

686

519 535 617449

618

451 400442

420

211

253162

149

118

0

200

400

600

800

1,000

1,200

1,400

1,600

2012 2013 2014 2015 2M2016

(annualized)SOE bond issuanceBOT bond issuance Thai government bonds issuance excluding T-bills

THB bn

Source: Bloomberg, CEIC, BOT, KBank Source: ThaiBMA, KBank

From the angle of public borrowings, larger supply of government bonds has been fully priced-in as it had been announced for a long time ago (i.e. about 13% increase from FY2015 to around THB460bn of government bond issuance for FY2016). So far, the auction has been well-received by market participants; we view that supply factor is unlikely to add negative pressure for market conditions at this stage. As for BOT bonds, the new issuance was structurally lower since 2013, this coincides with QE taper tantrum in May 2013 which reversed the trend of foreign capital inflows to outflows. In fact, BOT noted earlier this year that it will be reducing the amount of bond issuance by around 20% for each tenor (from 3-month bills to 3-year bonds); that should therefore have a positive impact for the market on supply factor. On SOE side, we expect the issuance to remain quite subdued as well, judging from the previous year pattern and our assumption of low domestic activities.

2) The demand for fixed income has stayed on a strong note from

both mutual funds and inter-bank players

High growth in fixed income net asset value (NAV) a nd strong net-buy from local funds supported market rally. While the supply of fixed income papers is expected not to add upward pressure on yields, we see relatively stronger demand for fixed income coming from domestic investors. Particularly, from mutual funds perspectives, total NAV for mutual funds in 2015 and early 2016, suggested a substantial gain in fixed income funds even though the markets have observed losses in equity side. Some part should be due to valuation but the confirmation that showed increased in the demand for fixed income is the net-buy activities of asset management companies (AMs) for bonds whose maturity is longer-than a year. The net-buy position from AMs rose to the highest seen since April 2015. Figure below suggested while local funds have poured large money in, offshore investors still have not shown much interest but only to speculate on short-term currency gain.

33

Fig 58. Mutual fund NAV development in 2015-2016 Fig 59. Net-buy/sell activities by mutual funds is

suggesting high demand for bonds

87.6

-0.1

78.3

-0.6

-50

0

50

100

150

200

250

300

Total NAV Equity funds NAV Fixed income funds

NAV

Mixed fund AV

2015 2M2016

THB bn

-60,000

-40,000

-20,000

0

20,000

40,000

60,000

80,000

Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16

Total net-buy /sell by asset management, THB mn

Total net-buy /sell by foreign inv estors, THB mn

Total net-buy/sell position over 20 days

Source: Bloomberg, CEIC, BOT, KBank Source: ThaiBMA, KBank

Bigger banks still have excess liquidity. While aggregate loan-to-deposit ratio (LTD) has stabilized over the recent months at around 90-91% (according to KResearch’s calculation), the estimated LTD ratio suggested that when segregating into banks with different size, the tightness in liquidity was found in medium-size banks (97-98%) whereas larger banks’ LTD has been relatively low at 87-88% (as of January 2016). This suggests that there exists excess liquidity to be managed and bond market channel should be one of facilities.

Fig 60. Inter-bank players’ excess liquidity can be

observed via low LTD ratio

Fig 61. NAV of FIF funds have been significantly falling

84

86

88

90

92

94

96

98

100

Dec-14 Jun-15 Dec-15

Large banks (4) Medium banks (4) Small banks (6) Total

100

200

300

400

500

600

700

800

900

1,000

Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Feb-16

0%

5%

10%

15%

20%

25%

30%

35%

Share of FIF to total mutual funds

Asset under management of FIFs (>80% in foreign assets)

THB bn

Source: KResearch’s calculation (from BOT’s data)

Note: Loans are estimated from net loans plus allowance to get gross loans

Source: ThaiBMA, KBank

3) Cost of going offshore is getting more expensive

The reversing trend of offshore portfolio investment has been observed since mid 2015 when net asset value (NAV) of foreign investment funds in Thailand saw a substantial decline. The fund’s NAV peaked in April 2015 at THB897bn and continued to fall to current value of THB727bn. The drop is much faster than that of mutual fund’s industry, bringing the share of FIF to total mutual funds down to 18% from 22% in April 2015 (the peak was at 25% during mid 2014). One of the reasons why we should continue to see such trend is because of the cost of asset swap is getting more expensive. Judging from the movement in basis swap trend, all tenor has been getting deeper into negative territory. The trend suggests that yield pick up outside Thailand must at least be greater than the cost of basis swap to attract investors to go offshore. We look at 2-, 5- and 10-year investment returns from going offshore, the return can be roughly

34

estimated by comparing THB IRS + basis swap vs. USD IRS. One will see that the gap has been closing for all tenors, making it less attractive to go offshore. If such trend persists, we expect those who could or may want to invest offshore for yield enhancement to remain in Thailand.

Fig 62. Cost of going offshore is increasing Fig 63. Return from going outward is not attractive

-250

-200

-150

-100

-50

0

50

09 10 11 12 13 14 15 16

2-year basis swap, bps 5-year basis swap, bps 10-year basis swap, bps

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

09 10 11 12 13 14 15 16

5-year USD IRS 5-year THB IRS + basis swap

%


Thai bonds are excessively rich; Hold off your investment

Although we are convinced that Thai interest rate will remain low compared to historical standpoint, one caution to note is Thai bonds are excessively rich. One indicator which points to that is the spread between 10-year Thai yield vs. UST yield, which is now the tightest since 2011. The only difference is that in 2011, the nominal yield on 10-year Thai bonds were high (ranging around 3.50-3.90%) i.e. about a 2% pick up from here. Given the difference in credit quality, we would expect at least 30bps in credit premium; this would suggest that if UST is holding in the range of 1.50-2.00%, 10-year TGB yield should be at least 1.80-2.30%. Thus, we do not expect further rally to persist and thus would hold off investment for a better entry.

Fig 64. Thai yield has flatten significantly (curve

change from the end of 2015)

Fig 65. Relative value between TGB and UST suggested

that this rally is not worth chasing over

-43-29

73

-7

80

8

-24

0

20

40

60

80

100

120

140

160

TH MA ID KR PH CN TW

-60

-40

-20

0

20

40

60

80

100

30/12/2015 Today, bps Change, bps, right

2-10 spread for selected Asian bond curve

-50

0

50

100

150

200

250

10 11 12 13 14 15 16

bps

10-year TGB-UST

Source: KResearch’s calculation Source: ThaiBMA, KBank

It should be noted that what could change the situation here is Thailand’s monetary policy decision. Our base case call is still the maintenance of poli cy rate at 1.50% for the rest of 2016. Yet, we do see the downside risk (rate cut) being more substantial than the upside one (rate hike), accommodating by global easing and more flexibility from undershooting inflation. For now, the possibility for rate cut in March meeting should be negligible but the meeting in May should prove to be a more interesting date in our view. Between now and then, the major central banks will already conclude their monetary decision (including the Fed, BOJ and ECB) and there will be meeting from central bank peers to BOT, including Indonesia, and South Korea who we found very interesting to watch for their development.

35

Economic Update

� The Thai Economy slipped into a go-slow mode again in January as

support from short-term boosts faded away. Given the sluggish growth

momentum from January data, we have assessed that economic growth

may perhaps slow in 1Q16 from the 2.8% growth YoY achieved in 4Q15.

� We at KResearch have revised our Headline Inflation forecast this year

down to 0.4% growth (range of 0.0-0.8%), versus our previous forecast

of 1.2% (range of 0.8-1.8%), because we expect global oil prices will

likely remain low during 1H16 and only a small recovery in 2H16.

� A calm situation in global financial market may not long-lasting. Going

forward, there are several challenges that could pose risk to global

economy, including the outcome of the referendum on the UK’s

membership of the EU, and China’s ability to manage a soft-landing.

2014 2015 2016

Units: YoY %, or indicated otherwise 2Q 3Q 4Q Nov Dec Jan Feb

Private Consumption Index (PCI) 1.1 1.4 0.0 0.7 3.1 3.3 3.9 1.2

• Non-durables Index 0.8 3.7 3.5 3.3 3.9 5.0 4.4 2.8

• Durables Index -19.2 -6.7 -11.3 -10.4 -2.0 -1.4 2.2 -6.3

• Service Index 3.0 6.5 7.2 7.7 4.2 4.2 4.6 6.2

• Passenger Car Sales -41.4 -19.1 -27.3 -24.9 -11.7 -12.0 -5.2 -30.0

• Motorcycle Sales -15.1 -3.7 -5.0 -16.4 -3.7 0.5 2.3 12.7

Private Investment Index (PII) -1.5 1.0 0.1 1.3 1.9 1.3 1.9 2.3

• Domestic Sales Volume of Cement -0.7 -0.8 0.5 -2.8 -0.8 -1.7 1.4 -1.5

• Imports of Capital Goods at constant prices -2.0 -0.8 -5.3 -0.3 3.1 11.5 -4.0 0.9

• Commercial Car Sales -26.8 -2.3 -16.1 -0.3 17.2 15.7 26.3 -2.7

• Domestic Machinery Sales at constant prices 6.4 9.7 13.5 10.5 4.8 3.1 5.0 9.3

Manufacturing Production Index -5.2 0.3 -0.3 0.9 0.3 0.3 1.4 -3.3

• Capacity Utilization 65.1 64.7 62.2 64.3 63.4 63.6 62.9 63.9

Agriculture Production Index 0.4 -5.3 -10.8 -10.6 -3.2 -26.2 42.9 2.8

• Agriculture Price Index -6.1 -6.1 -6.0 -4.9 -6.0 -7.2 -4.9 -6.3

No. of Tourists -6.5 20.4 36.9 24.9 3.7 5.1 4.7 15.0

Exports (in $) -0.3 -5.6 -5.5 -4.7 -7.9 -6.6 -9.1 -9.3

• Unit Value -1.0 -2.3 -1.8 -2.9 -2.7 -2.6 -2.7 -2.8

• Volume 0.7 -3.4 -3.8 -1.8 -5.4 -4.2 -6.6 -6.7

Imports (in $) -8.5 -11.3 -10.2 -14.5 -13.2 -8.5 -8.7 -17.8

• Unit Value -1.8 -10.8 -9.7 -11.7 -11.0 -11.0 -10.5 -8.3

• Volume -6.8 -0.6 -0.5 -3.2 -2.4 2.8 2.1 -10.4

Trade Balance ($ millions) 24,583 34,593 7,860 9,616 9,637 2,086 3,220 2,636

Current Account ($ millions) 15,418 34,839 6,119 7,225 13,055 2,997 4,879 4,066

Broad Money 4.7 4.4 6.1 5.4 4.4 4.8 4.4 4.0

Headline CPI 1.89 -0.90 -1.1 -1.1 -0.9 -0.97 -0.85 -0.53 -0.50

USD/THB (Reference Rate) 32.484 34.252 33.269 35.255 35.839 35.783 36.014 36.162 35.604

Sources: BOT, MOC, OAE, and OIE

Kanang Duangmanee, KResearch

[email protected]

Kangana Chockpisansin, KResearch

[email protected]

Warat Niamsa-ing, KResearch

[email protected]

36

The Thai Economy slipped into go-slow mode again in January after

support from short-term boosts faded away

Economic momentum slowed again in January as support from temporary factors such as accelerated car purchases before a new excise tax took effect, as well as some stimulus campaigns began to fade away. Many key indicators exhibited disappointing performance, e.g., private consumption (-1.6%MoM), private investment (0.0%MoM), the Manufacturing Production Index (MPI) (-4.2%MoM) and exports (+0.3%MoM). However, tourism continued to drive overall growth (+2.3MoM). Over-year, the Private Consumption Index (PCI) remained soft in January, growing at only 1.2%YoY, falling from 3.9%YoY in December. A major drag came from spending on durable goods that had contracted -6.3%YoY after accelerated vehicle purchases waned, while spending on semi-durables (retail sales of textiles and apparel, plus imports of textiles and clothing) decreased somewhat. Nevertheless, non-durable expenditures (household electric power consumption and motor fuel sales) had increased YoY as well as service sector spending, boosted by stabilizing non-farm income. The Private Investment Index (PII) improved slightly, rising to 2.3%YoY, versus 1.9%YoY in December. Car sales for investment plunged -8.5%YoY in January, versus 19.2%YoY growth in December, as businesses accelerated vehicle purchases at the end of 2015. Moreover, a slowdown in telecom and alternative energy sector investments had affected imports of capital goods by these sectors. However, domestic machinery sales managed to expand 9.3%YoY, especially electric motors and generators, as well as production machinery for plastic and rubber goods.

Fig 1. January growth slowed again Fig 2. Farm income and the MPI contracted after

temporary assists waned

Sources: BOT, KResearch Sources: BOT, KResearch

January Exports contracted -9.3%YoY (-8.1YoY, excluding gold) in line with the regional trend. The contraction was broad-based across categories due to weak demand from China and ASEAN economies, along with falling export values in commodity-related products, plus a slowdown in exports of optical appliances and instruments owing to a decline in global demand for electronics. Nonetheless, exports of electrical appliances to Europe improved with a view toward an expected hotter summer this year. The January Manufacturing Production Index (MPI) plunged to a -3.0%YoY contraction, blamed on sluggish export performance that led to falling production in many industries, e.g., electronics parts, textiles and apparel, as well as falling car production after short-

37

term supporting factors had faded. However, electrical appliance production rose on rising external demand. The tourism sector continued to expand for the fourth consecutive month with foreign tourist arrivals rising 15.0%YoY and 2.3%MoM to 3.0 million, boosted by a continued increase in Chinese tourists, as well as more from Europe, including Russia, after low cost airline service to Thailand was expanded. Given the sluggish growth momentum in January performance, we have assessed that it may be possible that GDP growth may slow in 1Q16 from the 2.8% growth YoY achieved in 4Q15. Despite supporting factors like accelerated government budgetary disbursements and economic stimuli, private spending may not rebound immediately. Meanwhile, weakening trade partner economies and severe drought that has become more apparent may cause exports and manufacturing to only narrowly recover, thus weighing on non-farm household income as well as spending. Headline Inflation remained in contraction for a 14th consecutive month in February at -0.50%YoY, partially increased from a -0.53%YoY reading for January on a high 2015 base and rising prices for some consumer products in February, e.g., fresh fruit and vegetables prices during the Chinese New Year, as well as on cigarettes because of a higher stamp duty tax. Over-month, the CPI rose 0.15%, after -0.26% in December. Core Inflation – which excludes food and energy prices – rose 0.68%YoY, from 0.59%YoY in January, and 0.18%MoM. The Ministry of Commerce (MoC) revised downward their 2016 inflation target to 0.0-1.0% (from a December forecast of 1.0-2.0%) using a new GDP growth assumption at 2.8-3.8% (from 3-4% previously), an average Dubai crude price of USD30-40/barrel (from USD48-54/barrel previously) and the Baht at THB36-38/USD. We at KResearch have also revised downward our Headline Inflation forecast this year to 0.4% (range of 0.0-0.8%) from a previous forecast of 1.2% (range of 0.8-1.8%), since we expect that global oil prices will likely remain low during 1H16 with only a small recovery in prices is likely to be seen in 2H16 (assuming an average Dubai crude price of USD40/barrel). Fig 3. Tourism rose on more Chinese and European

tourist arrivals

Fig 4. Headline CPI remained in contraction for 14th

consecutive month

Sources: BOT, KResearch Sources: MOC, KResearch

-0.5

0.68

-2

-1

0

1

2

3

-0.5

0.0

0.5

1.0

Feb-15 Jun-15 Oct-15 Feb-16

%YoY

%MoM

Headline CPI (MoM-lhs) Core CPI (MoM-lhs)

Headline CPI (YoY-rhs) Core CPI (YoY-rhs)

22.3

5

26.5

5

24.7

8

29.8

8

2.99 3.00

18.9% 18.7%

-6.7%

20.4%

4.7%

15.0%

-10%

0%

10%

20%

30%

40%

50%

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

2012 2013 2014 2015 Dec-15 Jan-16

No of Foreign Tourist Arrival % YoY (RHS)

Mill

ion

Per

son

38

Global Economy Update

No (bad) news is good news

Financial markets have been volatile since the start of the year. Much of this volatility is linked to concern toward the global economic outlook. China is a major vector in the global slowdown, their PMIs having submerged below 50 for 12 consecutive months. Negative spillovers have emerged in many developing countries, especially the commodity exporters. However, high anxiety in financial markets, alone, may not result in recession. As mentioned in the book, “This Time is Different”, by Reinhart and Rogoff, classical causes of financial instability come from banking, currency and inflation crises. The recent strong US data, rallying commodities, rebounding bank equities and the potential for more ECB and other central banks’ easing may become good news for global growth.

Fig 5. March saw a rebounding in global stock markets Fig 6. A decline in the VIX index suggested that anxiety

level has dissipated

70

75

80

85

90

95

100

105

Jan-16 Feb-16 Mar-16

Ja

n 1

,20

16

= 1

00

MSCI World

MSCI Emerging

Dow Jones

Nikkei

HS China

MSCI EU bank

MSCI US bank

0

5

10

15

20

25

30

Jan-16 Feb-16 Mar-16

VIX index

Sources: Bloomberg, KResearch Sources: Bloomberg, KResearch

In economic developments, we see some good news in the US and Europe. In the US, their job market is on a firm footing. Employment reports show that their unemployment rate is stable at 4.9 percent, with 242,000 jobs added in February and January being revised higher to 172,000 jobs. Also, their ISM manufacturing index rebounded in February. The Eurozone PMI ramains over 50, and employment is improving gradually. However, China, Japan and emerging markets are still lackluster. China’s economy is deteriorating. Economic growth there may face with serious headwinds in the coming months as China restructures industries with overcapacity. In his opening address to the National People’s Congress on March 5, Premier Li said growth over the next five years should average at least 6.5%; the new growth target for 2016 is 6.5-7.0%. Japanese consumers have avoided higher consumption amid rising economic uncertainty and exports still contracted for a 4th consecutive month amid weak global demand. In emerging economies, the data is lukewarm since many have experienced sharp export declines and fund outflows.

Emerging markets are facing a ‘new normal’

However, developing economies are facing hindrances such as manufacturing no longer being the main driver of their business cycles, and trade links with other nations in some cases weakening. Subpar global export data is evidence of this. The OECD has said that the world trade volume grew only 2.0% in 2015. In advanced economies, service sectors contributed rising shares to global output, employment and trade. The ‘digital age’ has not only hastened the creation of many new goods or services, but has also dramatically

39

changed the way entire categories of goods are created, produced, distributed, exchanged and consumed. Thereby, an export-led growth model may not help sustain long-term economic growth, and double-digit growth in global trade may be hard to achieve. A calm before the storm is again upon us

The current calm in global markets may not be long-lasting. Many countries have opted to muddle through it rather than devise comprehensive reforms. Monetary easing is being used as a common choice of resolution. Looking ahead, there are many challenges that we will need to face. Among them, the UK's EU referendum is the first litmus test of the year. Britain’s possible exit from EU – or a “Brexit” – has caused fear in markets after Prime Minister David Cameron scheduled a referendum for June 23 on the matter. A vote to exit from the EU could pose risk to the global economy as well as the overall EU integration. Second, China’s ability to manage an economic soft-landing will be another test. Although the Chinese authorities have the authority to actively respond to unexpectedly slow growth, markets doubt the ability of their government to orchestrate announced goals. If China chooses to devalue their currency as they did in the 1990s, it will be hard to avoid the resulting shockwaves that would ripple through global markets. Outlook for Next Month

February export will likely continue to report YoY contraction due to the sluggish economic data on China, which will lead to the YoY contraction for MPI as well. Meanwhile, March Headline CPI could increase over-month for the second month in a row on the back of rebounding global oil prices, but the YoY figure could remain in negative territory.

40

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.

.Mean S KBank Multi Asset Strategies Strategies...1 .Mean S Strategic Thesis OPEC nations in 2016...

Documents

Transcript of .Mean S KBank Multi Asset Strategies Strategies...1 .Mean S Strategic Thesis OPEC nations in 2016...