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Friday, March 13, 2009

Sovereign credit risks in Asia

Both Asian and US IRS markets have generally been hit with higher swap fixings recently, which has also put upward pressure on swap rates as well.

And while FX markets are playing a role in this dynamic, we think the primary driving factor is coming from US money markets. But rather than being a renewed fear of bank failures, we view the rise in US money market rates as a result of the quarter end turn (and fiscal year-end in Japan) which is producing a “kink” in the funding curve over the April 1 date. The rise in 3-mo LIBOR for example is completely accounted for by an increase in 1-mo rates. Space on bank balance sheets is simply becoming slightly more expensive.

The good news is that this should be temporary. We would expect the quarterend turn to have an impact for at least the next couple of weeks, but as we get into the second half of the month the impact should begin to dissipate. We would then expect to see a commensurate decline in funding rates.

Government bond supply is also remaining a key factor for the rates world but as we have emphasized in the past, we would not ignore the demand side of the equation here. Data released last week showed yet another significant increase in government bond holdings at commercial banks in Malaysia, and Thai banks are slowly building their positions as well. We think banks will mostly be focused on the front end of the yield curve however, which should obviously
lead to a steepening, although we favor the 5-yr / 10-yr curve in most cases.

Malaysia provides a good example of this where the 5-yr / 10-yr IRS curve has steepened to 120 basis points as the budget balance has deteriorated.

But we dedicate most of our time this week to the Asia sovereign market. Wefind that external liquidity is by far the most important factor for global EM markets, and by this measure we believe Asia generally makes the grade. This explains why regional CDS spreads are trading well relative to the rest of the globe.

And yet each country is facing its own unique issues which we discuss in the pages below. Our main conclusion is that even in cases such as Korea and Indonesia where external liquidity measures are somewhat concerning, we do not see a significant risk of default.

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