Bond Outlook

Local bond yields have continued to decline, while the curve has steepened. In October, the market saw fiveyear bonds fall by 55 basis points while 10year bonds dropped by 40bps. In November, we have continued to see yields decline, with fiveyear bonds dropping an addi¬tional 25bps and 10year bonds down another 13bps.

Demand has flooded into the market and driven bond yields down across the curve. This reflects the fact that investors continue to expect worsening economic conditions ahead and are hence holding on to their expectations of a deep rate cut. Markets have anticipated that the Bank of Thailand will cut rates at least by 75100bps into next year, starting at its December 3 meet¬ing.

Bond investors, particularly traders, have gradually extended their horizon to a longer duration, since yields of shorter duration become less attractive than funding costs at the moment.

In addition, the steepening of the yield curve offers better spreads at the longer tenor, while price sensitivity is also higher. Since October, the ontherun 10year yield (LB183B, modi¬fied duration = 7.41) went down 75bps to trade at 3.68 per cent yesterday. Meanwhile, the shorterduration, fiveyear (LB133A and mod¬ified duration = 3.88) yield is at 3.25 per cent, against the 4 per cent seen in October. The spread between the two issues now stands at 43bps, where the normal spread (mean) of the fiveyear/10year bond was 35bps - meaning the steepened curve offers a good trading opportunity.

On the supply side, on November 19 there was primary auction for 10year government bonds worth Bt10 billion (LB183B). The result was bid coverage of 1.73 times, while the auc¬tion rate was in the range of 3.7983.88 per cent. The accepted range was quite wide, reflecting the mixed trading sentiment of bulls and bears at that time (given a greater supply factor).

Profittaking was seen following the auc¬tion, but the yield did not spike up after poor monthend economic data came out, with annualised thirdquarter economic growth at 4 per cent, sharply down from the 6 per cent and 5.3 per cent posted in the first and second quarters, respectively.

As to the mediumterm outlook for bonds - with current liquidity looking trapped in the interbank market, as loan growth in 2009 is expected to decline following the severe con¬traction in global economies - we foresee a fur¬ther southward move in the yield curve, with a flattening bias.