Inflation Data Brings Philippines Into Deeper Negative Real Rates; NOT A Likely Cause of Today’s Decline

As expected, Philippine inflation rates leaped to its highest level in 3 years according to the news wires.

Chart courtesy of abs-cbnnews.com: Soaring Philippine Inflation Rates!

The following quote from abs-cbnnews.com, ``The price of rice, a staple in the Philippines, soared in April by nearly 25 percent from a year ago. Overall food prices rose 12 percent, the National Statistics Office said on Tuesday.” (emphasis mine)

Earlier mainstream analysts primarily attributed the rise of our inflation index to higher oil prices from which refuted in our March 5 post, “What we have been saying is that the surge in global commodity prices, which appears to be reflected in food prices, is likely to be more strongly associated with the recent uptick in our price index data than oil alone.”

And this was even prior to the emergence of the “rice crisis”. Now it appears that our view has been validated anew!

Remember the so-called inflation index is a LAGGING indicator, again to quote abs-cbnnews.com (highlight mine), “The Philippine’s annual inflation jumped to a near three-year high of 8.3 percent in APRIL, putting pressure on the central bank to raise borrowing costs despite the threat that could pose to economic growth”.

And implying stock market price movements based on a lagging indicator does not reflect the functionality of markets as forward discounting mechanism. Does the April data mean the same, better or worst for today?

In short, any attribution to inflation of the past as determinant of today’s market decline is all about “rationalization” or looking for a simplified explanation into today’s activities.

Notwithstanding, if inflation had been the “casual” agent responsible for today’s decline, why does it seem that even “inflation hedges” have been affected too?

The meat about the argument of inflation being a negative for the market is about pressures on corporate margins. Higher input costs and limited consumer pass through or pricing power crimps on corporate profitability. But this should not hold true for existing producers of commodities who are likely to benefit from rising values of “commodity products”.

It also means pressure on consumers in terms of declining standard of living.

An example would be this quote from Standard & Poors,

``In the world of higher commodity prices, corporate winners and losers fall into two distinct camps.

``Commodity producers are big beneficiaries. Their business outlooks appear generally strong and their ratings stable, in our view, as scarcity and worldwide demand affect everything from corn to copper. But companies that rely heavily on grains, oil, or other commodities to make finished goods face increasing costs, and thus weaker profits, if the slowing U.S. economy makes raising prices more difficult.

``The fallout from high commodity prices will be unequally distributed and determined by whether one is a buyer or seller of commodities. The level of commodity input into finished goods and the ability to raise prices will determine how serious the impact will be for commodity users. Low steel costs, for instance, are certainly better than higher costs for automakers. But steel is a relatively small part of a car's cost, and the woes of Detroit's Big Three (oil prices and labor costs, for example) go far beyond steel prices. Baked goods, cereals, meat, poultry, eggs, and dairy products all contain, directly or indirectly, large amounts of corn or wheat, so the impact of higher prices for those grains is widely felt among food processors. And the high price of oil will clearly be deleterious for industries like refiners or airlines, where oil is a major input.”

So when we see the market down with commodity producers similarly impacted, it is unlikely to be “caused by” inflation. Instead, it is likely caused by negative sentiment with all “excuses” lodged into it.

Moreover, if one notices the big drag to the sentiment today seems to emanate from the 8.28% decline of Meralco. While indeed Meralco stands only at 3.4% weighting of the Phisix, the purported action by the government to threaten a “takeover” if not a “change in management” is enough to create a pandemonium. Why? It is all about using populist politics as a cover to apply political vendetta or harassment. When government threatens (directly or indirectly) to “nationalize”, private ownership is compromised and thus, leads to destabilization.

Lastly, the world is into an inflationary boom. Inflation by the definition of a surfeit of money creation, massive credit expansion and re-intermediation, aside from spectacular speculative excesses.

The odd thing is that while we cheer the authorities to “save” the financial assets from being overwhelmed by market forces, paradoxically we jeer at the prospects of rising “product” prices when these systemic leveraging have mainly been responsible for the increased claims against limited resources, or too much money chasing too few goods.

No, product inflation will NOT move in a straight line. But for as long as people expect governments to provide more subsidies we should correspondingly expect such trend to be reflected in our way of living.

Further, on the account of the domestic scene, it will “pressure on the central bank to raise borrowing costs despite the threat that could pose to economic growth” as the report says.

This is what we wrote last April 6,

``As we have repeatedly said, negative real rates will likely trigger more speculative activities as the search for the alternative monetary function of “store of value” intensifies. This further reinforces more “inflation” within the domestic economic and financial system.

``So we may likewise expect the domestic central bank, the Bangko Sentral ng Pilipinas (BSP), to raise policy rates to keep up with rising treasury yields (falling bond prices)…

``Otherwise maintaining present rates amidst surging consumer price could lead to negative real rates across the entire yield curve, which should further aggravate the opportunity costs of holding cash.

``On the other hand, rising yields could lead to resurgent foreign capital portfolio flows predicated on currency yield spread arbitrages or carry trades."

So as the Philippines go deeper into NEGATIVE REAL RATES at the expense of savers and for added stimulus for borrowing and speculation, the BSP will be forced to raise rates. But contrary to expectations of further declines, rising yield spreads could as mentioned above entice foreign money into the markets which could increase inflation pressures.

Remember stock market investing cannot solely be explained by sheer earnings or economics (as previously explained), because it also reflects the function of money as a store of value.

chart courtesy of Wall Street Journal: OECD consumer prices

So even when the world (or OECD) has seen resurgent consumer price inflation…there seems to be no strong correlation about rising inflation and declining stocks yet.

chart courtesy of stock charts.com: Dow Jones Developed World Index

The Wall Street Journal Chart shows inflation accelerating in developed countries during the last semester of 2007 (red ellipse) even when the credit crisis was in the process of unraveling.

Yet, even as the appearance of a “peak” in inflation (based on the chart-but I don’t believe it has peaked), stocks has apparently recovered (which for some, signifies as a relief rally) in the backdrop of a “normalizing” US 10 year Treasury Yield.