How will the QE work through the economy?

How will the QE work through the economy?


While a new round of quantitative easing (QE II) by the Fed seems to be a foregone conclusion, the market remains skeptical about how effective it will be in spurring the economy. Before we can analyze its potential effectiveness, we need to address how the Large Scale Asset Purchase program (LSAP) works through the economy.

LSAP or quantitative easing is different from traditional monetary policy implementation in that quantitative easing has not been used as a signal of the future path of short-term risk-free interest rates. We can see that dating back to the time of the QE I, the Fed informed markets about the chance of raising short-term rates at the appropriate time while expanding its balance sheet. In contrast, the LSAP is being conducted for the purpose of narrowing risk premiums, which will in turn pull down longer-term yields. As the QE is perceived as a government life support that will help ease systemic risks, it will not only reduce the yields on assets being purchased, but also spill over into the yields on other assets.

Now we can look at how the QE I worked to reduce risk premiums. The risk premium is the additional return that investors require when holding risky assets. In our study, we use the difference in 30-year government bond yields and 30-year fixed mortgage rates to represent risk premiums. The risk premiums ran at 124 bps on average during the end of the 2001 recession and the onset of the latest recession (December 2007). The premiums soared 82 bps from 172 bps at the onset of the recession to peak at 253 bps, triggering the first QE in late November 2008. Subsequently, the premiums dropped markedly to uncharted territory at 28 bps in March 2010 when the Fed’s MBS purchase program ended. The premiums have since gradually risen by 36 bps to 64 bps as of September. At the current levels, the risk premiums are still well below the average of the past five recessions (200 bps). This implies that even though the new QE may not do much to further reduce risk premiums and long-term yields, it could at least help keep a lid on them. By putting a ceiling on risk premiums, the Fed is at the same time putting a floor under economic growth. Figure 1 shows a negative relationship between risk premiums and the ISM manufacturing index, with a correlation of 0.5. The graph also suggests that risk premiums higher than 150 bps can lead the ISM index lower into contraction territory.

Will China Set Its Consumers Free?

Will China Set Its Consumers Free?
Japan’s experience in recent decades indicates that when rapid growth begins to slow in an economy with very high corporate and household savings driving fixed investment, demand can prove extremely difficult to manage. This is particularly true if the deliberate promotion of credit growth and asset price bubbles has been part of the mechanism used to sustain demand. Levels of fixed asset investment and consumption were very similar to current Chinese levels in Japan in the early 1970s (and the horrendous pollution of unregulated industrialisation in a one party state) but Japan never made the transition to a truly free market allocation of capital and maintained an implicit producer subsidy right through the bubble years. Anyone visiting Japan at the time from Europe or the US was struck by the relatively poor living standards of the average Japanese, despite world leading GDP per capita.

KBANK: Growth acceleration, but opex higher - Hold (Target Bt123.00)

KBANK: Growth acceleration, but opex higher - Hold (Target Bt123.00)


Event: 3Q10F earnings preview and outlook

Key highlights

Expected 3Q10F at Bt5bn (+5% QoQ and +34% YoY)

Amidst loan growth and margin recovery, the slow Q-o-Q growth will come from lower bancassurance and acceleration of opex. Meanwhile, the strong Y-o-Y growth comes from both NII (+23%) and non-NII growth (+24%).

Loan growth acceleration in 3Q10 and beyond 4Q10

Although 8M10 loan growth at 4.8% is only half of its FY-10 target of 7-9%, signs of loan drawdown from the corporate and SME segments keep its FY-10 target valid. This guidance means MoM loan growth of 1% for the rest of this year, indicating strong NII growth momentum going forward.

….but cost overrun for K-transformation

However, the K-transformation capex budget for improving the core banking system has been significantly revised up by 25-30% from the original budget of Bt15bn, with the project’s completion to be delayed by 6-12 months to 2013F due to the complexity and longer test run. Assuming that the additional costs are capitalized with 10-yr amortization, this should incur additional expenses of around Bt600-700mn p.a. (or at 3% of net earnings) and keep the cost-to-income ratio high at 55% until 2012 (vs. 50% avg. at 3 big banks).


Hold with TP-12M of Bt123 (PBV of 2.0X)

In order to offset the cost overrun, we believe that KBANK will need to lower credit cost by around 5bps (from 70bps to 65bps). Lowering provision expenses to that level makes sense given its continued low NPL inflow, lowest NPL ratio at 3.5% and high coverage of 104%. Incorporating 3Q10F, 9M10 makes up 80% of our FY-10 forecast. With limited upside target price, we downgrade recommendation from buy to hold.