MARKETS BRACE FOR THE HAWK-DOVE GAME

The financial world continued to be buffeted by geopolitical events last week. Tensions flared after North Korea tested a nuclear weapon and China responded by conducting anti-missile tests over the Yellow Sea.

The nuclear test marked an escalation in Pyongyang’s brinkmanship, following the launch the week before of a nuclearcapable missile that passed over South Korea and Japan. Toward the end of the week, there was speculation that Pyongyang was planning to test-launch more missiles, rattling investors and causing global risk assets to slump.

Meanwhile, there were rising concerns about the US debt ceiling. A failure to increase the ceiling before Sept 29 would have put the US in default for the first time, which would definitely result in a credit rating cut. In 2011, S&P downgraded the US credit rating by one notch from AAA to AA+, triggering a 15% plunge in the Dow.

Finally, wrangling continued over the budget allocation for President Donald Trump’s border wall. Trump had said earlier that failure to reach an agreement on the issue would lead to a government shutdown. That last happened in late 2013 after Congress failed to agree on fiscal 2014 funding as Republicans demanded changes to Obamacare.

Some of those concerns have since eased. Senate Minority Leader Chuck Schumer and House Minority Leader Nancy Pelosi made a deal with Republicans to raise the debt ceiling until Dec 15 and provide government funding for three months, as well as to speed up Hurricane Harvey aid.

There were also other positives for risky assets, including a string of dovish comments from Federal Reserve policymakers. Four Fed presidents — Lael Brainard, Neel Kashkari, Robert Kaplan and William Dudley — noted separately that inflation remains below the Fed’s target and urged caution on lifting rates.

The similar comments from the four officials gave the market encouragement that the Fed will hold off on its next rate hike until next year. Adding to the optimism is the pending resignation next month of Fed vice-chairman Stanley Fischer, who is perceived as one of the central bank’s more hawkish members.

The market will keep a close watch on who Trump selects to succeed Fischer. If the front-runner is considered a dove, the possibility of a delay in the next rate increase should increase and global bond yields will slide further, including that on the Thai government 10-year bond.

Narrowing bond yields suggest investors will embrace more risk exposure in equities. Historical data show the Thai 10-year yield has an inverse relationship to the SET’s forward price:earnings ratio (PER) based on a correlation of -0.64. We thus believe the falling yield curve will push the SET Index to trade at a higher forward PER than at present. We expect the SET Index to soon advance to test our target of 1,650, equivalent to forward PERs of 15.59 times in 2016 and an estimated 14.5 times in 2017.

Prakit Siriwattanaket is a vice-president with Kasikorn Securities.