Fear and loathing in the world of finance

There are many reasons for this. The removal of the 30-per-cent capital controls in early 2008 (does anyone still remember what URR stands for?). The recovery of investor risk appetite from the 2009 recession (especially as Asian economies recovered more quickly than elsewhere). The record expansion of money supply in the US (and its effect on global liquidity). 

All these factors mean that foreign investment has been increasingly flowing into and out of Asian countries, including Thailand. 

Looking at just data from the local stock and bond markets (which likely represents only a portion of overall flows), net movements often exceed US$1 billion per week. In previous years, these net flows were usually lower than $500 million per week. 

The fear and greed that drive international financial markets is therefore increasingly affecting Thailand as well. Movements in the dollar-baht exchange rate are very much linked to the frequent changes in global risk appetite. 

The big theme in recent months has been the ongoing crisis in Europe. Will France be downgraded? (Yes.) Will Greece be able to refinance and restructure its debts? (Remains to be seen.) On a daily basis, movements in the dollar-baht have closely tracked the changes in the rate between the euro and dollar. Whenever the euro strengthens or weakens, so does the baht. 

And yet, investor focus is rotational, and quick to change. Even as Europe’s problems remain unresolved, another key issue is beginning to arise – monetary policy prospects in the US. 

In late January, the Federal Reserve (which acts as the central bank for the US) surprised everyone with its emphasis on loose monetary policy. The Fed noted that interest rates are likely to remain extremely low until the end of 2014 (from the previous suggestion of mid-2013). The Fed’s aggressive signals also raise the possibility of another round of quantitative easing (popularly referred to as QE3). 

Quantitative easing is an expansion of the money supply, and previous efforts have been associated with a fall in the value of the dollar. Investor fears about QE3 have already dampened sentiment on the dollar, and to some extent overshadowed the news flow from Europe. 

All this has implications for the baht as well. Previously, when the baht was highly correlated with the euro, bad news out of Europe meant that the baht weakened. That relationship is beginning to die down. Baht movements are now looking to be more affected by news out of the US, with any developments that are likely to cause QE3 (poor US economic data, or comments from the Federal Reserve) leading the baht to strengthen. 

Thailand’s recent flooding has also had an unintended impact. The huge disruption to country’s manufacturing sector has also had a negative impact on exports and on the Thailand’s overall trade balance. This scenario may not change until the manufacturing sector fully recovers – probably around the middle of this year. Hence fundamental, real-economy factors have had even less of an impact on the foreign exchange market.  

Going forward, the trend for international financial market integration is likely to continue or even intensify. The local exchange rate will continue to depend on rapidly-shifting global sentiment. 

This also suggests a potential increase in volatility for the baht exchange rate. However, that issue may be somewhat mitigated by the Bank of Thailand, which usually plays a positive role in preventing very excessive day-to-day movements in the baht. Implied volatility for the baht has usually been lower than that of other regional currencies, and it would be a big surprise if that changes. 

The upshot of all this? Don’t assume big one-way movements in the dollar-baht exchange rate. Hedge foreign exchange exposures if possible. And keep a close watch on what goes on in London and New York. 

 

Parson Singha is chief markets strategist, Global Markets Department, HSBC Thailand.