Sunday, August 17, 2008

Philippine Peso Wilts Under The Unwinding Short US Dollar Carry Trade!

``The world is changing and how we measure that change economically and financially is clearly a challenge and an opportunity. We have seen a re-weighting of risk around the world, but the world itself is being economically re-rated and so we need an index that allows investors to take advantage of these changes. Indian companies will obviously have a place in The Global Dow as will companies from other emerging countries where we have seen an unprecedented economic emancipation over the past two decades.” Rupert Murdoch, owner Dow Jones, on the Global Dow plan, in Mumbai, India.

So what ails the Philippine Peso?

After a fierce rally following the Philippine central Bank the (Bangko Sentral ng Pilipinas) BSP’s move to raise policy interest rates to quell “inflation”, the Philippine currency made a 180° turn and dived. The Peso lost 2.19% over the week to 45.13 to a US dollar see figure 1, Asia’s second biggest loser after India’s Rupee.

Figure 1: USDollar/Philippine Peso: Ailing Peso?

Local mainstream media ascribes the recent activities on several factors as foreign portfolio outflows “on jitters over rising inflation”, “heightened concerns over global economic growth”, “lower commodity prices”, “hedge against potential recovery in oil prices” and “low levels of liquidity” in the financial markets.

There seems to be some confusion about “rising inflation” and “lower commodity prices” (which is which? Isn’t rising inflation supposed to be represented by higher commodity prices?), aside from concerns about global economic growth as a causal factor to Peso’s steep loss (how does slower “global” economic growth translate to lower Peso?).

So from previous concerns over “inflation” to now “global economic growth”, media and the local experts appear to be lost on what truly is driving the Peso’s decline.

The Inflation Bogey Revealed

While it is true that foreign portfolio continued to account for outflows that have weighed on the Peso, we doubt if the premise is indeed ALL about “inflation”.

Proof? See Figure 2.

Figure 2: What Inflation? Where?

ADB’s Asianbondsonline depicts of the Philippine Peso denominated sovereign instruments in 2 year (green line) and 10 year (red line) yields. As the chart shows, the sharp drop in the yields last month seems to be validating our arguments that inflation concerns have been abating as discussed in Philippine Economy: World Financial Markets Allude To Diminishing Risks of Inflation.

With LOWER food prices, which is our MAIN concern (over 45% of our Consumer Price Index basket is in food while energy is just about 3%), manifested by sharply falling broad based commodity prices, via moderating “global and local” demand compounded with supply side responses from market forces and from policy directives emanating from political pressures (subsidies, interest rate hikes, added investments and etc.), the falling yields reflected in Philippine debt papers have equally signified diminishing inflation risk over the interim.

Since government “inflation” figures represent past data, this accounts as a LAGGING indicator. So when you read of Philippine inflation rates nearing a 17 year high in July at 12.2% (, we should expect these figures to drop significantly in the coming months. In short, consumer goods and services inflation has peaked!

So from this angle, inflation as a risk variable hasn’t been the MAIN impetus for the Peso’s decline.

Slowing Global Economic Growth Weighs On The Peso? Not Likely

Now if the argument swings to one of global growth, economic data doesn’t seem to support such a premise either.

One must be reminded that the currency values are ALWAYS priced in pairs. That’s why currency markets function as a zero sum game because when one wins, the other loses.

This means that the conventional measure of the Philippine Peso is relative to the US dollar, since the US dollar represent as the de facto world currency reserve. This also means that if we allude to the world economic growth’s impact on the Philippines, then we must also account for how the same factors will affect the US.

Let us see how the downturn abroad has impacted the Philippine Economy…

According to the latest remittance trends, June’s money flows from overseas foreign workers set a NEW record in the face of a SLOWING global economy! (Yeah…“decoupling is a myth”??!!)

This from Bloomberg (highlight mine),

``Remittances from Philippine citizens working overseas rose at the fastest pace in 14 months in June as more people found jobs as nurses, seamen and engineers abroad.

``Money sent back to the Philippines jumped 30 percent from a year earlier to $1.5 billion, the highest since records began in 1989, the central bank said in a statement in Manila today. Remittances grew 15.6 percent in May.

``The number of Filipinos who got jobs overseas rose 33.5 percent to 640,401 in the first six months of the year, the central bank said today…

``Slowing global growth may limit jobs abroad as companies lay off workers and freeze expansion, reducing the amount of money expatriates can send home in the coming months. Half of the Philippines' remittances come from the U.S., where tumbling home prices, mounting job losses and credit restraints are threatening growth.

``Funds sent home by the more than 8 million Filipinos living abroad climbed 17.2 percent to $8.2 billion in the first half of 2008 from a year earlier.”

Remember, remittances account for about 10% of the local economy and have SUPPORTED consumption patterns in the Philippines. The fact that 3 of the 10 largest malls in the world are in the Philippines (see our blog post A Nation Of Shoppers??!!) could be seen as partly being propped up by these fund flows from our migrant workers. Thus as far as labor and financial links are concerned, the global economic slowdown hasn’t been reflected YET in these accounts.

Although it is true that the risks of a negative impact to remittances from a slowing global economy may have a lagging effect, as in the case of Mexico which reported a slight decline during the 2nd quarter and the first semester of 2008 (Wall Street Journal), these would actually depend on the sectors from which our OFWs are exposed to.

According to the BSP, ``Filipino workers continue to be in strong demand overseas due to the diversity and quality of skills they offer. The conduct of bilateral talks with host countries also continues to open up new employment opportunities abroad for Filipinos.” (emphasis mine)

Much to our knowledge, health (caregivers and nurses) and science based industries (engineers) aside from education (teachers) could be seen as defensive sectors that are least likely to be affected by the ongoing economic and financial slump in the US, thus the seeming resilience.

Aside, as the BSP has noted, bilateral agreements has effectively widened the opportunities for more of our labor/manpower exports.

Paradoxically, it appears that the so-called “Peso-driven-remittance” premise formerly touted by media and our experts has vanished altogether! Why? Just because the Peso is down and seems not to be supported by the remittance flows doesn’t mean this has no contribution. This goes to show how media and the highly paid institutional “experts” frequently resort to specious analysis based on AVAILABLE Bias.

Might as well abide by Nassim Taleb (author of the Black Swan) advise, ``Don’t read newspapers for the news (just for the gossip and, of course, profiles of authors). The best filter to know if the news matters is if you hear it in cafes, restaurants... or (again) parties.”

Going back to the local economy, if we look at the performances of publicly listed companies, we hardly notice any significant slowdown. Yes while earnings fell (from a jump in input costs or “inflation” and from mark down on equity investments), revenues from business operations jumped!

This from ABS-CBN (emphasis mine), ``Companies whose shares are listed on the local bourse saw their total earnings fell in the first quarter of the year due to rising inflation and lower trading gains, a new study by the Philippine Stock Exchange (PSE) showed.

``According to PSE data, the combined profits of listed firms amounted to P66.68 billion in the first three months, a 4.3-percent decrease over the previous year's P69.67 billion. The same study showed that their combined revenues expanded by 10.4 percent to P589.71 billion from P534.05 billion a year ago.

``The findings were based on the unaudited financial statements of 221 listed companies received by the PSE as of June 11.”

Of course past performance doesn’t imply the same prospective outcome, but the point is if the largest companies in the Philippines have been seeing strength in the revenue context, then a material slowdown (or even a recession) isn’t likely to be in the cards. So the world may go into a recession alright but we are unlikely to join the bandwagon.

Besides, except for the trade linkages seen via the export and export related manufacturing channels, which supposedly accounts for as the most sensitive or the weakest link to a global slowdown (ironically exports grew 8.3% in June year on year, and 4% from January to June over the same period last year), the rest of the other industries should remain resilient.

As evidence, we can get some clues from the latest export figures (…

``Exports of clothing and accessories, the second-biggest export item after electronics in June, were down 7.6 percent year-on-year at $172.33 million.”

``Other top exports in June were petroleum (down 1.0 percent at $138.71 million), cathodes of refined copper (up 97 percent at $122.16 million), and coconut oil (up 105 percent at $116.97 million).

So there…a downturn in global consumer spending is reflected through the decline in clothing and accessories exports. Meanwhile, agriculture (coconut oil) and mining and related (refined copper) industries should continue to experience robust growth. As reminder, agriculture accounts for a substantial-over one third of the Philippine employment profile.

Not only that…the ongoing economic slack in the OECD economies have been prompting more firms to consider the outsourcing avenue as a way of cost cutting.

In the US, investment banks suffering from the housing and mortgage backed securitization meltdown is seen accelerating the outsourcing of jobs or in the vernacular- “knowledge process outsourcing,” “off-shoring” or “high-value outsourcing-to emerging markets.

This from the New York Times (underscore mine),

``Cost-cutting in New York and London has already been brutal thus far this year, and there is more to come in the next few months. New York City financial firms expect to hand out some $18 billion less in pay and benefits this year than 2007, the largest one-year drop ever. Over all, United States banks will cut 200,000 employees by 2009, the banking consultancy Celent said in April.

``The work these bankers were doing is not necessarily going away, though. Instead, jobs are popping up in places like India and Eastern Europe, often where healthier local markets exist.

``In addition to moving some lower-level banking and research positions to support bankers and analysts in New York and London, firms are shipping some of their top bankers from those cities to faster-growing developing markets to handle clients there…

``After research, the next wave may include more sophisticated jobs like the creation of derivative products, quantitative trading models and even sales jobs from the trading floors.

``Proponents of the change say Wall Street’s wary embrace of the activity may signal the beginning of a profound shift in the way investment banks are structured, with everyone but the top deal makers, client representatives and the bank management permanently relocated to cheaper locales like India, the Philippines and Eastern Europe.”

We don’t like to sound like engaging in a schadenfraude but the article message is crystal clear-someone’s loss is somebody’s gain; very much like the tradeoff between the Peso and the US dollar.

So, in addition to the milestone remittance volume in June and the prospects of a lower “inflation”, plus a calibrated upswing in the rest of the other industries economic growth figures to the upside (Government expects the country to grow by 5.7% for the year (!!!

Figure 3: San Francisco Federal Reserve: World Real Economic Growth and US Real GDP

So under the context of economic growth, we don’t expect the US to OUTPERFORM emerging markets including the Philippines, as shown in Figure 3 from the San Francisco Federal Reserve even under a very OPTIMISTIC scenario of a NO-recession economic recovery in the US (right pane), an outlook which seems as questionable for us.

Besides, even under a moderation in economic growth it is unlikely that emerging markets will undergo the same penance as those in the debt to the eyeballs OECD economies. Even during the bust of 2000-2002, emerging markets contributed 75% to the world economic growth as seen on the left pane. Lately, the emerging countries or developing countries accounted for almost 70% of world real GDP and should remain as an important driver going forward.

Thus, the recent fall by the Peso isn’t also supported by the slow economic growth thesis.

The Unraveling Short US Dollar Carry Trade!

So if it is not inflation and it is not slowing global economic growth then what is?

The recent strength of the US dollar hasn’t been a Philippine Peso only phenomenon. It has been a broad based rally seen in Asia (except Indonesia) including the redoubtable Singapore or for much of the world as shown in Figure 3 as measured by the US dollar “trade weighted” Index.

Figure 4: US dollar rally

As shown in Figure 4 the US dollar (main window) has massively rallied against its major trading partners (except the Canadian Loonie) which apparently coincided with the collapse of commodity prices, CRB Index (pane below main window), Gold (pane below CRB) and Oil prices (lowest pane).

While others have imputed these to “deflationary” pressures which may be partly responsible for the recent events, but has been inconsistent with the activities seen in the equity markets, we think that today’s volatile actions in the currency market signify the rotating process of “deleveraging”.

Perma bears cheerfully claim that the breakdown of commodities signifies a collapse in EM demand-which we think is unproven yet- and not evident in the Philippines anyway.

While others may call it the “global margin call” we call it the unwinding “short US dollar carry trade”.

Said differently, the US dollar has almost functioned as a ONE WAY BET or one huge crowded trade where international investors have massively “borrowed” against (because of relative lower rates) or “shorted” the US dollar (in expectations of a lower US dollar because of the years of continued decline) to buy commodities or emerging market assets or ex-US currencies in the hunt for added yields.

When central banks intervened (as we pointed out in Global Markets: The End Of The World? Or Overestimating Global Consequences?) to put a floor on the US dollar, the entire short US dollar short phenomenon unraveled spectacularly!

The attendant margin calls from the US dollar carry spurred forced liquidations in the positions of the commodity trade or in emerging markets or even among the currencies of the major trading partners of the US which had morphed into a dysfunctional rout. Hence, the almost synchronous inverse actions of the US dollar relative to commodities and the rapid disorderly panic stricken selloffs involving many currencies including the Philippine Peso!

This has not been a new phenomenon. About a year earlier, the advent of the credit crisis resulted to a wallop in global equity assets as many financial institutions who were caught in the subprime mortgage shakeout were compelled to raise capital via forcible liquidations. Most of these were vented in the global equity markets including the Philippine Stock Exchange.

We are seeing it happen today again, but this time involving ex-US assets. Hence the rotating disorder of delevaraging from a system that greatly relies on leveraging.

In May of 2006, the Gavekal Team wrote about the parallelism of a short US dollar phenomenon which had contributed to the imbalances or bubble formation that became what is known as the Asian Crisis (emphasis ours)…

``We had an echo of this very same phenomenon in Asia in the period 1995 to 2000. In 1995, everyone was convinced that the THB, MYR, KRW were massively undervalued and due a large revaluation. Everyone borrowed US$ (since rates were cheaper than local rates) to finance local projects (usually real estate). As money continued to plow in, returns on capital weakened. Soon the returns on capital moved below its cost and Asian currencies were forced to devalue. Asian banks, and the OECD banks that had lent to them, found themselves de facto “short the US$”. As Asia repaid its US$ borrowing in the period 1997-2000, the US$ rose higher than anyone expected (including ourselves) and central bank reserves barely grew (despite large current account deficits).”

Deleveraging and Probable Policy Goals Behind Interventions

The process of forcible liquidations almost always involves indiscriminate selling regardless of the fundamentals of an asset. This is because the antecedent of deleveraging is overleveraging which constitutes inflation, excessive speculation and reckless risk taking.

And deleveraging of overvalued or overextended markets means raising capital to fund margin deficits by closing out positions which usually is directed at the most liquid or most profitable positions. Hence deleveraging is commonly seen within a universe of a specified asset class. In today’s case: currencies and commodities.

Even gold, which traditionally functioned as hedge against volatility, inflation or financial or economic distress, became a downright victim to the latest market carnage.

An added view is our suspicion of the coordinated Central Bank-government efforts to prop the US dollar to force down commodity prices so as to reflect a peak in “inflation”, thereby relieving them of the political pressures from the responsibilities of policy errors (e.g. Biofuel subsidies).

Also we suspect that the same political forces could be conditioning markets for further policy easing measures (more rate cuts) in view of the still recalcitrant gridlock in the credit markets whose adverse impact has begun to spread into the real economy.

Finally in understanding of the guiding principles of US Federal Reserve Chairman Ben Bernanke policymaking, it is likely that such actions could have been designed to bolster or cushion equity markets especially under the seasonal conditions of August to October which have been prone to “crashes”!

In 2000, Chairman Ben Bernanke wrote a treatise entitled “A Crash Course for Central Bankers” which we quote Mr. Bernanke…

``There’s no denying that a collapse in stock prices today would pose serious macroeconomic challenges for the United States. Consumer spending would slow, and the U.S. economy would become less of a magnet for foreign investors. Economic growth, which in any case has recently been at unsustainable levels, would decline somewhat. History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.”

Figure 5: BBC US Market Crashes Through Ages

Figure 5 which we featured almost at the same time last year (see A “Normal” Correction in the FACE of Massive Government Interventions? No Can Do!) exhibits the worst crashes and bear markets in the US.

Given the cognizance of the unfolding weaknesses in the economy, US markets could be deemed as sensitive or vulnerable to a stock market crash, hence Mr. Bernanke alongside with other central banks could be attempting to create conditions that could avoid a similar situational risk.


In finale, we don’t share the mainstream view that the Philippine Peso’s recent downside jolt emanates from either the popular premises of being “inflation” impacted or as corollary to a global economic slowdown, both of which seems to have inadequate evidences and rests on tenuous logic in support such claims.

Much of the inter-market activities reflect on the process of deleveraging from an overextended-ONE way bet market (US DOLLAR) that has led to unruly forcible liquidations involving cross volatilities in the currency and commodity markets.

We suspect that political entities have had a hand in the present market actions were aimed at mitigating the political cost owing to adverse impacts of policy errors or US policymakers could be conditioning global financial markets for further policy easing measures (more rate cuts) or that alleged market intervention had been designed to bolster or cushion equity markets especially under the seasonal conditions of August to October which have been prone to “crashes”!

We further suspect that the unfounded serial bouts of forced selling should also translate to opportunities similar to that seen in the Phisix-that the Philippine Peso should rebound after the smoke from the battle clears.

1 comment:

G.Doran said...

Excellent article.... Thanks!

"the Philippine Peso should rebound after the smoke from the battle clears"

Did not bargain on a Nuclear Winter though... I think we are now talking half-life. 2009 and 2010 are definitely negative growth and high inflation unless a brave team cut interest rates to pump some money into the three largest Malls anywhere with no customers.