Last week, we saw the baht testing the important support line of 29.66 to the US dollar, which it last touched 18 months ago. It did not last very long, bouncing back rapidly to 29.75 only an hour later. But just to appreciate the significance of the moment, the baht was only an inch away from the historical low of 29.35 reached early in 2008.
The latest round of sharp currency appreciation started early this year _ on Jan 2 to be exact. That morning, the US Senate passed a bill to make permanent the income tax cuts for most American households. This and other measures, for all practical purposes, reduced the size of the dreaded "fiscal cliff" by more than two-thirds. The bill was also readily _ and surprisingly _ passed by the US House of Representatives, effectively putting the US economy back on track with expected gross domestic product (GDP) growth at about 2% this year.
Shortly afterward, global risk appetites improved. As investors were willing to hold fewer dollars and more of other currencies, the baht gained almost a percentage point (0.88%) against the greenback. It also rose against other major currencies by a similar order of magnitude _ 1.6% against the yen, 0.99% against the euro and 0.81% against the British pound.
But the real action began when the baht broke 30 to the dollar on Jan 15, most likely in response to the announcement of aggressive monetary and fiscal stimulus in Japan. As Prime Minister Shinzo Abe told the broadcaster NHK: "The economy isn't going to change unless we display a firm commitment to escape deflation at the same time."A week earlier, Mr Abe had announced a spending package worth 10.3 trillion yen (3.38 trillion baht) to spur GDP growth, reflecting his firm commitment. Needless to say, the baht strengthened by another 1%.
Some economists argued such appreciation of the baht is warranted by Thai economic fundamentals. "Equilibrium has been restored _ hurray!" they say. Strong domestic demand is now a main driver of Thai GDP, supported by government schemes _ e.g. spending on infrastructure and flood protection systems. Inflationary pressure is stable, with core inflation comfortably within the Bank of Thailand's target range.
While we don't generally object to the above conjecture, it didn't address the recent rally of the baht fully, especially the timing. Why now and not last year when domestic fundamentals were almost identical? Here are a couple of "stylised facts" we find to explain this round of appreciation:
Stylised Fact 1: The baht is probably driven more by external factors. The triggers of the baht rally turned out to be the agreement to avert the US fiscal cliff, which directly affected demand for dollars, the value of the greenback and then the dollar-baht exchange rate. Similarly, Japanese stimulus packages, announced later in the month, have driven down the value of the yen as intended, so investors need more yen to purchase the same amount of baht.
The performance of Thailand's capital markets also is attracting capital inflows and heightening the demand for baht. As of Monday, the baht had gained 3.64% against the dollar from a year earlier, second only to the Philippine peso (4.59%) within its Asian peer group. This was in line with the performance of Asean's two best-performing stock markets: the Stock Exchange of Thailand index as of Monday was up by 36.8% from a year earlier, and the Philippine PSEi by 32.3%. Thai bond returns are also alluring, with 10-year yields, for example, rising by 50.8 basis points from a year earlier _ investors can now buy cheaper Thai bonds.
Still, timing is difficult to gauge. Interestingly, more than half the 3.64% baht appreciation mentioned above _ i.e. about 2% _ took place within the past month. Most other Asian currencies including the yuan, South Korean won and Singaporean dollar, had already "secured" most of their gains 3-6 months ago.
Strange as it sounds, the baht hardly reacted _ when measured against the norm of the recent rally _ to massive liquidity injections by major central banks, be it QE3 or QE4 of the US Federal Reserve or additional monetary easing by the Bank of Japan (BoJ) late last year. That, as we mentioned before, cannot be reconciled completely with the fundamentalist view.
Stylised Fact 2: "Hot" money operates with a trickle-down effect. We think a more plausible explanation to the above puzzle is the trickle-down effect of "hot" liquidity. Let's put on the hat of a mutual fund manager who needs to balance risk and return on investments. Investing in emerging markets has long been known to yield lucrative returns at a cost of higher risk. But not all emerging markets are created equal, and some more advanced and stable ones are safer than others.
So naturally it would take a while for liquidity to arrive in less developed markets like Thailand. Our hypothesis could explain why the appreciation of the yuan, won and Singaporean dollar preceded that of the baht. Capital flows to Thailand have been pent-up and delayed. But now they are here, all at once. As a result, they are making baht appreciation appear very fast and furious.
The recent rally of the baht can thus be viewed as a sentiment-driven correction process by the foreign-exchange markets _ something that should have happened awhile back were there not a trickle-down phenomenon.
When the BoJ upset markets by holding off further bond purchases until next year, the exchange rate between the baht and the dollar shot up to near 30 once more, making a rarely seen but sort of attractive U-shaped curve. But could this be an "anti-catalyst"that would put a brake on baht appreciation? Or would the decision just slow it down?
One thing we know for certain though: a new BoJ governor will take office in April, and an even more aggressive monetary policy is probably in the pipeline. By that time, we may see another rally in the baht. But until then, we may have to endure the awkward movements of the baht _ or rather the lack thereof _ once more.
TMB Analytics is the economic analysis unit of TMB Bank. Behind the Numbers is co-authored by Benjarong Suwankiri and Warapong Wongwachara. They can be reached at TMBAnalytics@tmbbank.com