Rate Swaps Signal Tightening on Inflation Risk: Southeast Asia

Rate Swaps Signal Tightening on Inflation Risk
A chicken stands at a market stall in Bangkok, Thailand. Photographer: Brent Lewin/Bloomberg

Interest-rate swaps in Malaysia and Thailand are signaling central banks will start to tighten monetary policy next year for the first time since 2011, as fighting inflation takes precedence over economic growth.

Malaysian and Thai contracts in which investors exchange a fixed payment for a floating rate for two years climbed to four-month highs of 3.18 percent and 3.08 percent, respectively, in September. Societe Generale SA recommends clients pay the swaps in Malaysia targeting an increase to 3.35 percent. Goldman Sachs Group Inc. raised its forecasts for five-year rates in both countries on Sept. 19.

Southeast Asian nations are expanding at a faster pace than economists predicted this year, even as Europe’s debt crisis and unemployment in the U.S. reduce export orders. Analysts including Societe Generale’s Wee-Khoon Chong and central banks are starting to flag inflation risks for next year, driven by rising domestic demand and funds pumped into the European and U.S. financial systems.

“Swaps in emerging Asia have more upside because they were too low as investors and traders were looking for multiple rate cuts, but now the world is slightly better,” Chong, a fixed-income strategist in Hong Kong, said in a Sept. 28 interview. “The pressure is for swap rates to go higher as sentiment is turning better with measures from the European Central Bank and Federal Reserve.”

Europe Risks

Asian central banks have lowered borrowing costs over the past year to bolter economic growth, as Europe’s financial crisis deepened and expansion in the U.S. faltered. Goldman Sachs raised its forecasts for swaps last month on speculation the global downturn reached bottom in the third quarter.

The five-year rate in Malaysia will climb to 3.7 percent in 12 months, the highest since August last year, Fiona Lake, a Hong Kong-based economist at Goldman, wrote in a research report on Sept. 19. The contracts were at 3.35 percent as of 11:41 a.m. in Kuala Lumpur, according to data compiled by Bloomberg. In Thailand, same-maturity swaps will rise to 3.8 percent, a level last seen in April, Lake predicted. They were 3.28 percent today.

The Bank of Thailand reduced its one-day bond repurchase rate by 25 basis points each in January this year and November to 3 percent. Policy makers in Malaysia have kept borrowing costs at 3 percent since May 2011, when they last raised the benchmark after three prior increases.

“Asian rates still remain below where their fundamentals suggest they should be trading,” Lake wrote. “Inflationary pressures are likely to start to rise, although slowly and we expect European risks to dissipate further.”

Schroder Inflation Doubts

Consumer prices in Thailand gained 3.38 percent in September from a year earlier, the fastest pace since March, official data showed yesterday. Inflation may quicken to 3.5 percent in 2013, from 3.3 percent this year, Somchai Sujjapongse, head of the finance ministry’s fiscal policy office, said in Bangkok Sept. 25.

In Malaysia, the cost of goods may rise as much as 3 percent next year, compared with a maximum 2.5 percent estimate for 2012, the government reported on Sept. 28.

Rajeev De Mello, who manages $7 billion of debt as the Singapore-based head of Asian fixed-income assets at Schroder Investment Management, is less concerned about inflation. The global economy will remain weak, keeping prices and interest rates low, he said.

“I have some difficulty in thinking inflation is going up,” De Mello said in a Sept. 28 interview. “Growth is actually weakening. In the next six months, policy is either on hold or a bias to ease.”

Swaps Spreads

Credit Agricole CIB is recommending so-called steepening trades, or bets longer-maturity interest-rate swaps will rise faster than those at the short end. The gap in Asia has widened, reflecting investors’ expectations for tightening.

The spread between Malaysia’s two- and five-year contracts reached 20 basis points today, compared with an eight-month low of 11 basis points in June, according to data compiled by Bloomberg. In Thailand, the difference was 31 basis points after touching 12 basis points on July 25, the least in 11 months. The margin in Indonesia was 35 basis points, compared with a seven-month low of zero on July 3.

Indonesia should be ready to tighten monetary policy as accelerating economic growth boosts inflation, according to a report from the Organization for Economic Cooperation and Development on Sept. 27, which predicted the nation’s consumer prices may rise 4.7 percent next year from 4.2 percent in 2012.

Rate Curve

“Looking at the longer-term horizon, there’s a chance Indonesia will raise interest rates in the first quarter because domestic demand has been very strong,” Pang Cheng Duan, who helps manage $37 billion of Asian fixed income as head of debt in Singapore at Manulife Asset Management, said in a Sept. 28 interview. He declined to comment on investment strategy or provide specific forecasts.

Indonesia’s economy expanded 6.4 percent in the second quarter, beating the median estimate in a Bloomberg survey for 6.1 percent. Malaysia’s gross domestic product rose 5.4 percent, compared with the predicted 4.6 percent, while Thailand grew 4.2 percent versus 3.1 percent.

“Asian interest-rate curves are very flat and steepening could be a trend,” Frances Cheung, a strategist at Credit Agricole in Hong Kong, said in a Sept. 27 interview. “As long as there’s no recession, the curves should steepen, although moving only gradually as there’s still concern over growth.”

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