Red Alert: Philippine Bonds Warns of Rapid and Dramatic Deterioration of Domestic Liquidity Conditions!

A loose Fed monetary policy (i.e., a positive sloping curve), sets in motion a false economic boom — it gives rise to various false activities. A tighter monetary policy, which manifests through an inversion of the yield curve, sets in motion the process of the liquidation of false activities (i.e., an economic bust ensues).—Austrian Economist, Frank Shostak

In this issue:

Red Alert: Philippine Bonds Warns of Rapid and Dramatic Deterioration of Domestic Liquidity Conditions!

-Yields of T-Bills Soars!

-Yield Spreads: From Flattening to Inversion!

-Yield Inversion: Symptoms of Balance Sheet Problems

-The Implications of Negative Spreads

-Weak Peso Compounds on Liquidity Squeeze, the 3Q Foreign Investments as G-R-O-W-T-H Mirage

-Phisix 6,900: Desperation Calls For The Rampant Use of Marking the Close Pumps!

Red Alert: Philippine Bonds Warns of Rapid and Dramatic Deterioration of Domestic Liquidity Conditions!

I am supposed to be on a holiday break, but recent developments at the Philippine bond markets have been too compelling to ignore because they have been signaling significant turn of events.

A week ago, I wrote about the intensifying signs of the flattening/inverting of the domestic yield curve as one of the factors that should not only inhibit any meaningful return of risk appetite, but likewise amplify the risk of an economic recession, as well as, risk of a credit crunch.

Apparently, this week’s market activities only reinforced my suspicions.

Yields of T-Bills Soars!

The above represents nominal BPS week on week changes

As of last week, yields of 3 and 6 months bills have rocketed! 5 year yield also jumped!

Perhaps most of the bond yield manipulators went on a Christmas vacation too soon for the surge in yields to have been unleashed.

Nevertheless, to repeat this has NOT been a HOLIDAY dynamic.

The following charts of the yields of 1, 3, and 6 month should tell us why.

Whether seen on a weekly (left) or monthly (right) basis yields of ALL three short term bills (again 1, 3 and 6 months) have spiked to MILESTONE HIGHS!!!

To put milestone in perspective, the weekly rates have been HIGHEST since 2014, while the monthly rates have likewise been HIGHEST since 2012!

However, investing.com charts have been limited to these time frame perspectives. And I suspect that the current yield have reached levels MORE than the demonstrated years.

And with the longer end little changed, the result has been a drastic and a dramatic curve flattening!

What you see depends on where you stand. So let us widen the angle to see how bond yields performed on a year to date basis.

Again the same dynamic holds: The yields of the short to mid end curve have been ascending FASTER than long term counterparts.

And that’s the reason why we have seeing the flattening to inversion process.

Now such dynamic now applies to almost the entire domestic bond spectrum!

Yield Spreads: From Flattening to Inversion!

Nevertheless, considering that the 10 year bond yield has been used as the mainstream’s benchmark, I will use them here to compare with the bills and notes counterparts.

I have noted during the mid-week that the coupon yield of the 1 month bill soared to a shocking 3.96%, but the yield has partly backed off from its high last Friday.

Now the above charts shows the spread between soaring yields of T-bills and 10 year bond equivalent.

The 10yr-1 month spread has narrowed to just 66 bps! (upper window)

The 10yr 3 month spread has dived to just 140 bps! (middle window)

And worst, the 10yr 6 month has collapsed to an astoundingly paltry 18 bps differentials! (lower window)

In short, the front end of the curve appears to be fast approaching an inversion!

Again the above charts reveal that this has NOT been anomaly but an extant dynamic for at least one year. It’s just that recent developments have been accelerating or escalating!

Let us move on to the spreads of the 10 yr relative to longer 1 and 2 year notes.

Apparently both have been plagued by the same flattening conditions as with T-Bill contemporaries.

It’s true that the above spreads have somewhat or marginally widened from previous levels last week, but they remain at landmark lows (as shown by the red arrows)!

Moreover, like the front face, the spreads above have been flattening from last year, but has only intensified during the last quarter.

Understand that the 10yr – 2yr benchmark has been a favorite bellwether by mainstream institutions like ADB. So perhaps current improvement on the 10yr-2yr maybe due to interventions to facelift the curve’s conditions.

However whatever cosmetic changes being applied by manipulators, it appears that they haven’t been successful in the concealment of the inversion process.

As I have earlier pointed out, it’s not just flattening anymore, negative spreads have already appeared.

For the FOURTH STRAIGHT week, the 10 yr-3 yr yield spread remains NEGATIVE!!!!!!!!!!!!

…and apparently, negative spreads have not been confined to 10 yr and 3yr anymore, they have now been joined by….

…the 10yr-5yr where the curve’s spread just crashed to negative last week!

This is totally stunning!

Yield Inversion: Symptoms of Balance Sheet Problems

The crux is: The abrupt narrowing of spreads has now spread to envelop the entire Philippine treasury curve.

The question is WHY has this been happening?

The obvious main answer is that there is no such thing as a free lunch forever.

Balance sheet growth has inherent limits. The continuing massive bank credit inflation has caused short term rates to rise relative to the longer end.

Despite headline profits, many highly levered firms have HARDLY been generating sufficient cash flows to pay for existing liabilities. Many firms have been using NEW debt to pay for EXISTING debt. And these have partly been ventilated through heightened demand for short term loans. Importantly, these firms have been competing intensely with each other for access to these scarce funds.

Meanwhile, as part of exercise to meet current funding requirements, holders of existing short to mid end papers have also been frantically selling these securities to spur the upsurge in yields!

This is simply a symptom of the unraveling of malinvestments.

Remember, that only a few entities in the population have access to the formal credit (banking/bonds) system. Hence, the zero bound to negative spreads are symptomatic of increasing concentration of credit risks!

And such inversion dynamic appear to be signaling the intensification of financial stress within the system.

Now the mainstream would like to blame the US Federal Reserve for current developments. Yet the above charts exhibit that the FED may only be an aggravating factor and not its main cause.

The Implications of Negative Spreads

And think again of what the evolving spreads will do to bank lending activities. Or what will happen to the banking system’s maturity transformation (borrow short, lend long)?

The compression of Net Interest Margins will force banks to sharply reduce credit activities. And loans represent about half of banking assets.

And with the BSP’s 2009 pivot to spur domestic demand through “expansionary monetary policy” in order to embellish statistical GDP, this entailed the entrenched dependence on credit.

As of 3Q, for every Php 3 of loans issued by the banking system (BSP current production loans) such has only generated Php 1 of government’s inflated NGDP (GDP at current price)!

Given that I believe that NGDP has been INFLATED, then the credit/NGDP ratio or credit intensity must be HIGHER!

And any material reduction in credit activities will NOT only diminish statistical GDP, it would raise credit risk as well! Remember, credit money accounts for about 70% of domestic liquidity (76% M3 October 2015), hence a fall in credit activities will translate to a drop liquidity (money in circulation) which should distill into GDP (NGDP and Constant ‘real’ GDP)!

Think of what happens to asset markets too. If the so-called ‘fundamentals’ of asset markets have been juiced up by credit, then the reduction of credit activities will deduce to its deterioration.

And if asset market pricing (boom) has similarly been pillared by credit, then diminished credit activities would substantially lessen demand for risk assets!

Said differently, a reduction of credit activities will lead to a substantial repricing of the considerably overpriced and mispriced assets.

Hence, overpriced and mispriced assets maybe vulnerable to violent adjustments (a.k.a crashes)

2015’s surge in yields should also translate to financial losses for institutions who bought these debt papers during its heydays. However, accounting classification may have shielded them from revealing their actual status. The recent DBP ‘market manipulation’ controversy provides clues to such dynamics.

Now if half of the banking balance sheets have constituted loans and other the half have been divided into financial (and property) assets, and fees, then both will similarly be vulnerable to a downturn in economic activities and from a hefty repricing of assets.

To make a long story short, this means there will be a transmission and feedback mechanism through the sequence of slowing credit growth to NGDP to earnings to asset pricing to credit risk and vice versa.

Developments in the Philippine credit market have been in sharp contradiction to what the mainstream has been projecting. For instance Fitch ratings has recently sold the chestnut that Philippine banks appear to be in tiptop conditions. Fitch appears to be reading statistical leaves while overlooking market signals.

For most of the mainstream, statistics or historical numbers only matters. Crucial market signals, especially one that affects the core of the present GDP G-R-O-W-T-H template, much like basic economics, exists in a vacuum or a black hole.

Furthermore, if yield compression will force banks to substitute volume for margins, then obviously this will come at the expense credit quality, thereby amplifying credit risks.

As I recently wrote: So the banking system must be so desperate as to seek margins by gambling away depositor and equity holder’s resources through the assimilation of more credit risks by lending to entities with poor or subprime credit ratings.

Of course, higher yields don’t just imply credit risk, they also expose many sectors to interest rate risk!

Weak Peso Compounds on Liquidity Squeeze, the 3Q Foreign Investments as G-R-O-W-T-H Mirage

And to compound on the tightening liquidity noose has been the sustained weakening of the peso.

Not only will an infirm peso increase prices of imported items, it will reduce demand for peso assets, and more significantly, it will magnify the onus from foreign denominated liabilities. That’s because a weak peso means more pesos to service every US dollar debt owned.

The flagging peso continues to draw foreign money away from domestic financial markets. Foreign money exodus also contributes to a wobbly peso. It’s a feedback loop. Foreign portfolio according to the BSP posted net outflows last November.

Forgive me, but I would question government’s relentless efforts to exorcise the deterioration in real economic activities through the repeated shouting of statistical talismans.

By real economic activities I don’t mean constant ‘deflator adjusted’ prices. Recall that constant ‘deflator adjusted’ prices magically transformed negative into positive performances in 3Q GDP.

Instead, I allude to a living and breathing, and not an artificially constructed puffed up numerical economy.

While it may be true that government statistics which show foreign investments up 165% in Q3, one quarter does not a trend make.

Moreover, foreign investments numbers tend to be extremely volatile. Having said so, they don’t imply G-R-O-W-T-H!

History shows us why. From 2010 through 2015, two out of six years posted negative 3Q growth, specifically in 2012 -35.14% and in 2014 -44.32%. (green circles). So from a statistical perspective 3Q 2015 data shows of a base effect: current numbers reflect a reversal from the troughs of 2014.

Also this implies of little correlation or even causation with GDP. Foreign investments cratered even when GDP climaxed in 2012!

Additionally, correlation between foreign investments and the peso (BSP’s monthly average end of 3Q) have been loose so far. (top window) This again suggests that the low USD-php volatility in the recent past has had little influence on foreign investments. Such relationship may be altered when currency volatility crescendos.

Worst, historically, huge nominal gains have coincided with collapses, as seen in 1997 and 2008! (orange ovals)

And the same phenomenon applies even on significant gains in terms of % growth, as seen 1997, 2001 and 2005 (peaks in blue trend line).

Besides, foreign investments are not like foreign portfolio flows, where the latter tends to reflect on real time market activities.

Foreign investments have to be “approved” by respective government authorities or regulators. This means foreign investments have to undergo the political bureaucratic screening process by specific agencies based on technical legal guidelines as prescribed by the national government. So it would be obvious that such statistical numbers and or the release thereof would involve certain political elements or contain some degree of political influence. And given the embedded nature of politics on foreign investments, what stops the government from either ‘timing’ its release or embellishing such numbers? Given that government operates as monopoly, who will be there to verify on the authenticity of those numbers? Yet we are supposed trust those numbers.

Nonetheless there has been little evidence where the government’s recent liberalization contributed to the spike in 3Q foreign investments. That’s because except for agriculture and energy, it’s mostly the bubble sectors which benefited from the recent surge in foreign investments.

Besides, given the amplification of the risks of a global recession, this will not only affect foreign investments but likewise magnify risks of protectionism. Because inflationism represents an implied protectionist policy, it is INCOMPATIBLE with liberalization. And the consequence of inflationism will unfortunately (to my dismay as libertarian) lead to protectionist impulses or more politicization of the marketplace, the APEC boondoggle notwithstanding. The domestic strongman rule bubble already serves as manifestation of the rise of populist protectionist politics.

At the end of the day, with monetary conditions rapidly and severely tightening, unless such juncture radically improves, then 2016 should be a mainstream SHOCKER!

As final thought, if the shrinkage of domestic liquidity will lead to deflationary pressures, particularly in parts of the economy where areas or industries have been afflicted by excess supply and debt overhang, on the other hand, the weak peso will lead to inflationary pressures on areas dependent on imports. So the Philippines will likely see a coming stagflationary environment—a simulacrum of the post 1997 era.

Phisix 6,900: Desperation Calls For The Rampant Use of Marking the Close Pumps!

The Phisix stormed to a 1.96% gain over the week on a very low volume rip.

As for the volume, at an average of Php 5.55 billion, daily volume signified the FOURTH lowest for the year! So essentially sellers took advantage of aggressive bids to unload on high prices.

But what has really been striking has been the rampant “marking the close” sessions used to attain the week’s gains.

On Monday, the Phisix losses hit a peak of 1.8%, approached the runoff period down .64% but shockingly closed up by .16% from a spectacular two issue pump! Marking the close produced a whopping .81% swing to turn negative into positive!

And 58.2% of SMPH’s eye-popping 8.25% jump to a new record high came from a last minute pump. And so with GTCAP, where 82% of the day’s 6.02% gains came from marking the close.

Since SMPH ended the week at Php 21.8/share or down Php 1.15 from the record Php 2.95, it’s really sad to see how price fixing actions by some entities have led to undue losses on resources used for such desperation headline enhancing pumps.

The same applies to GTCAP which closed at Php 1,262, though up 3.19% for the week, had been down Php 37 or 2.8% from the Php 1,299 pump.

I posted the egregious price fixing session here.

This wasn’t limited to Monday.

Friday’s session saw the Phisix down by 1.09% prior to the runoff (see upper window). All of a sudden, the Phisix closed down by only .56%! This shows how 49% of the day’s losses had been wiped out from Friday’s price fixing session! A four issue pump had been used to bolster the index.

Hasn’t it been an oxymoron to think the Philippines have supposedly reached “developed economy” status yet depends on brazen price fixing or cheating its way to attain such ends?

Last week’s rally was more than just about low volume, it was also about divergence:

Among the 30 composite issues constituting the PSEi index, 23 issues posted advances, 6 posted losses while 1 was unchanged.

In contrast, the broad market was tilted heavily in favor of sellers (lower right window). Declining issues topped advancing issues by 99. Declining issues led in 3 out of the 5 trading days of the week.

Such divergence reveals of the cosmetic actions to festoon the headlines.

It’s really a spectacle to see how price fixers have been frantically attempting to prop the index up in the face of shrinking liquidity. It’s an example of picking up coins (pennies) in front of steamroller founded on hopium.

And sad to say hopium has never been a good strategy.