Against the tide: Market uprising vs The Fed’s monetary policy 

Given timid inflation, the smart money could keep buying long-end bond and flatten the US treasury yields curve. 
The yields curve’s slope, described by the spread between the US-10 year yield and the US-2 year yield could become less steep as the market keep rejecting the Fed’s tightening plan. 
Flattening yields curve or decreasing yields spread during the Fed’s tightening cycle is not new to the market. Theoretically, when the yields spread turn “negative” or “yields curve inverted”, it does a spectacular job of predicting a recession. As a matter of fact, the inverted yields curve in 2000 and 2007 did correctly forecast recessions after the dot-com bubble burst and the great financial apocalypse. 
Judging from weak US economic data, the market’s actions seemed to be justified and they could be right to doubt the Fed’s ability to hike an interest rate one more time in the second half of this year. If the market turn out to be right, the potential of inverted yields curve could point to possible the US economic slowdown in the near future. 
In order to gauge how deep the yields spread could be, one could utilize well-known technical analysis “the dead cross”. The dead cross signal occurs when long term trend is higher than shorter trend (the market typically use 50 days moving average for short-term trend and 200 days moving average for long-term trend). Since 1999 until now, 9 out of 10 dead cross signals had been followed by a deep dive in yields spread. 
So what if “this time is not different”? The latest dead cross on the yields spread, flashed on May 23 2017 would pose an early-warning of another downturn in the US economy. One should not take this cue lightly as potentially swift fund outflows could lead to not only a bloodbath in global equity market but also a sharp depreciation of Thai baht by 7 per cent on average.
However, what if this time “it is really different” from what the market believe and the inflation actually flare up to reach or beyond Fed’s 2% target. The consequence could be a severe U-turn for bonds market. Global bond rout could stem from the US market and spread across the globe. Unavoidably, strong fund inflows into EM bond market especially Thai bonds market (year-to-date net fund inflows about 150 billion baht) could be reversed and lead to baht depreciation. 
In addition, on top of Fed’s tightening plan, “unwinding of massive quantitative easing measures” from the European Central Bank and the Bank of Japan could potentially dampen the fund flows into EM region. Both central banks may decide to taper their quantitative easing program and hike their interest rate by 10 basis points next year. If both central banks begin to tighten their monetary policies like the Fed, the bond market rout could be similar to “QE taper tantrum in 2013”. Regardless of which sides; the market or the Fed (or the central banks) will be correct about the state of global economic growth and future trend of inflation, market participants and business owners should be aware of the possible outcomes from both scenarios. For business owners, the results from both cases will coincidently lead to baht depreciation, thus it is highly recommended for them to keep hedging FX risks. Lastly, it is important for everyone to learn the history of the previous financial crises and recessions and prepare plans to survive during such dire situations. 
Views expressed in this article are those of the author and not necessarily of TMB Bank or its executives. 

POON PANICHPIBOOL is Economic Specialist at TMB Analytics. He can be reached at [email protected]