Global interest rates are clearly on the rise

Thursday, June 21, 2007
[[Ref : Thailand outlook]]
Global interest rates: where to now?

BRIAN HOEGEE

Global interest rates are clearly on the rise. The move in the US 10-year treasuries over the past months is starting to grab headlines, spook investors and most importantly, confirm that rates are on the rise.

Numerous central banks including those in the UK, EU and Australia have increased interest rates. Just six months ago, investors were banking on a Fed cut. Now the big question is, will chairman Ben Bernanke actually raise rates and if so, when?

Thailand, on the other hand, is coping with its own domestic problems such as lacklustre GDP growth, excess liquidity, low consumer confidence, political turmoil and occasional spurts of inflation. These factors, along with questionable leadership, have driven away foreign investment and depressed corporate earnings, contributed to poor performance by SET Index.

The Bank of Thailand (BoT) finally realised it needed to cut interest rates. Unfortunately, the damage was already done. The sad thing for investors is that this policy blunder caused investors to miss out on one of the biggest bull markets in Asian history.

Interest rates globally used to rise and fall in tandem, giving investors little opportunity to diversify their risk. What we see now, however, is a totally different dynamic with some central bankers increasing rates (Europe, Australia etc.) while others (Thailand, Indonesia and Brazil) are decreasing. Each country now stands on its own two feet independently.

Thailand is a classic example proving the point that the Fed isn't the only central bank that we should be paying attention to.

Taking a look at global interest rates. There is a huge disparity between interest rates and central bank policies.

The range varies from 0.5% in Japan to 5.25% in the United States, 8.5% in Indonesia, all the way up to 17.25% in Turkey. Thailand, of course, is currently at 3.5% and many expect the BoT to cut rates further. Clearly, central bankers have a much more difficult job than they did in the 1980s or '90s. Maximum growth with low inflation guides current policy.

Due to the rise in commodities, housing prices and consumer items (primarily food), central bankers must now seek to tame inflation first, then worry about growth.

European interest rates are at six-year highs and are forecast to rise further in the next six months. US rates have gone from 1% in 2004 to 5.25% currently. US and European growth has been above average, but inflation has been the main concern.

But are higher interest rates really such a terrible thing? Not at all. The mere fact that interest rates are rising indicates central bankers are trying to cool the economy. In fact, since 2004 the Fed has increased rates by 425 basis points - at the same time the Dow Jones has gone up by around 90%. Stronger economic growth leads to buoyant corporate earnings translating into higher stock prices.

When things get a bit too hot, central bankers naturally step in to cool things down. As for Thailand, the recent cuts by the central bank will start to show benefits in the fourth quarter of of 2007 and well into 2008. Expect a V-shaped recovery in corporate earnings with stock prices moving ahead as fund managers and investors buy stocks ahead of earnings upgrades.

On the other hand, most sceptics will say that higher interest rates will inflict pain on private-equity houses, force housing prices to retreat and most of all cause the China bubble to burst. As stated in previous columns, the only investors or strategists calling this a bubble are the ones who sold already or are not invested. Some are saying that the move of 50 basis points in the US 10-year bill will force private-equity houses to reconsider new investments due to higher costs of funding.I liken private-equity transactions to the high-end housing market - those at the top end in New York or Beverly Hills are selling just fine and will continue to sell in this environment. Bond bears will also tell you that interest rates are at their lowest level in 50 years. In the mid-1980s, rates were around 13% globally; in 2003, that number was just 3%. If rates do go back to 10% or more globally, there will be financial ruin for many.

Whether your view is one of bond bull or bear, hedging your interest-rate risk is no easy task. Products such as contract-for-differences, which provide access to global bond markets, are the most efficient and cost-effective way to access them.

Brian Hoegee is Managing Director, Asia, of Global Trader, a leading London-based derivatives provider registered with the Thai SEC. Contact him in Bangkok at 02 625 3120 or visit http://www.gt247.com.