Retail square feet per capita in the United States is more than six times that of Europe or Japan. And this doesn't count digital commerce. Our industry, not unlike the housing industry, saw too much square footage capacity added in the 1990s and early 2000s.Thousands of new doors opened and rents soared. This created a bubble, and like housing, that bubble has now burst. We are seeing the results: doors shuttering and rents retreating. This trend will continue for the foreseeable future and may even accelerate. Another consequence of overcapacity is discounting and endless promotions as retailers try to drive demand through lower prices. This causes Average Unit Retail deflation and erodes merchandise margins.— Richard Hayne, CEO of Urban Outfitters
In this issue
Appetizers…
Main Course: The Mainstream Finally Embraces the Weak Peso…
…But Sees Politics as Main Driver
It’s the Supply of the Peso, Stupid!
Dessert: Interpreting Government Data: Putting Square Pegs in Round Holes
Appetizers…
The coming week should be very exciting.
1) The US Fed has been widely expected to hike interest rates: Fed Futures Probability was at 88.6% as of March 10, 2017.
2) The suspension of the US debt ceiling expires on March 15. This comes as the US treasury’s cash balance has shriveled to a speck: USD 34.015 billion (as of March 9, 2017, Daily Treasury Statement) from USD 339 billion (February 1, 2017,DTS). Such comes at a time of highly partisan or very divisive politics in the US. What happens if no terms of agreement would be reached?
3) The Netherlands general elections take place also during the ides of March. Though slightly trailing in polls, will another populist far right candidate Geert Wilders spring a surprise?
Main Course: The Mainstream Finally Embraces the Weak Peso…
…But Sees Politics as Main Driver
The consensus view of the peso has truly been amazing. The establishment consensus has finally come to embrace the decline of the peso. I am not on the fringe anymore.
But they continue to see the pesos' frailty from a different lens.
From the technical aspect, they see momentum as driving the peso. Though this is something I agree on, they have a distant perspective on the fundamentals behind it.
They see politics as largely driving the peso lower.
Domestic politics, like the ongoing sensational revelations of unlawful killings and corruption by the incumbent president,have reportedly “spooked” the peso. While I would concur that this may have some influence, in particular, on the demand side of the peso, this should signify the skin rather than the heart of the peso’s basic flaws.
Domestic politics runs in the framework of less than a year. This means that in the eyes of the mainstream, three years of the peso’s decline just vanished into a void. That’s mainstream economics for you.
The other assertion is that US politics may harm OFWs remittances and outsourcing. Though this has been something that I have repeatedly presented here, this would only account for the “flows” and the likely “stock” from these “flows” of the domestic US dollars.
Figure 1: Changes in February GIR, Forex Derivatives
And speaking of “stocks”, the BSP reported its GIR condition for the month of February which fell by US $244 million on a month on month basis.
The BSP explained: “The month-on-month decline was due mainly to outflows arising from the BSP’s foreign exchange operations and the payments made by the National Government (NG) for its maturing foreign exchange obligations. These were offset by net foreign currency deposits by the NG (which include the net proceeds from the new money component of the ROP Global Bonds issuance) and revaluation adjustments on the BSP’s gold holdings resulting from the increase in the price of gold in the international market.”
So GIR stocks now include proceeds of the $2 billion bond sales by the national government in January. Additionally, GIR gold reserves got a 3.5% boost even when the gold prices increased 2.84% only in February. This entails to a likely addition of gold stocks by the BSP last month. (To the BSP, pls. buy more gold to back the peso).
However, the BSP’s foreign investments posted a huge USD 507 million deficit. Aside from proceeds, the BSP’s forex position, which has likely been composed of currency derivatives (fx forwards), reached another apogee.
So February’s GIR would have registered a much bigger decrease had it not been for gold prices, from the proceeds of the bond sales of national government and from the record recourse to currency derivatives to bolster its position.
Yet the BSP’s GIR conditions have become increasingly vulnerable. Much of what has signified as “stocks” have really been just borrowed USD. Since borrowed USD has a cost, rising USD php and rising LIBOR rates will likely increase the costs of maintaining or expanding the use of leverage to hold borrowed stocks of USD.
The BSP’s GIRs reflect on the ongoing US dollar “shorts”.
More and more entities have used fx derivatives to substitute actual holdings of US dollars.
It’s the Supply of the Peso, Stupid!
Yet more importantly, totally absent in any discussion from the mainstream is the supply side of the peso. It is as if the peso supply has no significance at all.
Yet again this is what mainstream economics is all about.
Statistics, which it confuses with economics.
As I continue to admonish, the BSP’s monetization (silent stimulus) of the national government deficits won’t come for free. [Another Bullseye!!! Record BLOWOUT in 2016 Fiscal Deficit Mainly Financed by the BSP! March 5, 2017]
Figure 2: Real economy prices, CPI, Core, GRPI and PPI. Treasury Yields
While the stimulus has initially rekindled a credit boom in 2016, thereby initially providing a boost to NGDP, corporate gross sales and earnings and tax collections, the secondary pass-through effects through real economy prices have become even more pronounced.
Further, I said that the earlier surge in oil prices will likely compound on the inflation statistics, as predicted last February,[Signs of Historic Times? Online Broker Warns on Wild Speculative Punts! February 19, 2017]
Oil prices have plunged only in late 2015 (December) to 1Q 2016. This means that the transmission mechanism from the 1Q oil price crash in 2015 and the oil price surge of 2017 should only be felt now (1Q 2017).
Bullseye again! The BSP and the Philippine Statistics Authority reported that their February Consumer Price Index zoomed by 60 basis points to 3.3% from 2.7% in January
From the BSP: “The increase in headline inflation rate was traced mainly to higher prices of food items, electricity rates, and domestic petroleum products. Food inflation rose further as key food items—particularly meat, fish, milk, cheese, and eggs as well as vegetables—posted higher prices during the month. Likewise, rice prices also inched up with the end of the main harvest season. Meanwhile, non-food inflation was pushed up by upward adjustments in electricity rates (due to an increase in generation and transmission charges), as well as by higher prices of gasoline, diesel, kerosene, and LPG.” (italics mine)
Even the BSP’s core inflation (exclusion of some food and oil components) has flown off the shelf! (see figure 2 upper left window)
As a side note, should the recent drop in oil prices persist, this would partly reduce headline pressures. But since credit boom and government spending has pillared the current rise in real economy prices, for as long as such conditions prevail, price pressures in the real economy will continue.
Recall that the PSA’s General Retail Price index (GRPI) soared by 4.4% last January. January growth has even topped its price zenith in 2014. 2014 was the period when M3 soared by 30+++% in 10 consecutive months.
Yet the GRPI’s spread with the policy sensitive CPI continues to widen (upper right window). And given the huge spike in February CPI, the likelihood is that surging GRPI will even accelerate further in February.
And it’s not just consumer wholesale and retail prices, as well as, construction retail and wholesale prices, now even the manufacturing sector’s Producer’s Price Index (PPI) has stormed to the positive, last January. January’s 2% growth has even surpassed the 2014 high!
And rising inflation rates have spilled over to the bond markets.
With the exception of the 5 year, yields of Philippine treasuries have risen across the curve year to date!
Interestingly, the domestic yield curve has been flattening as yields rise.
Domestic bank stocks have rallied strongly in the assumption that higher rates will translate to bigger Net Interest Margin (NIM).
Ironically, the pseudo stock market has forgotten that interest rate represents a price. Rising rates will not only dampen demand for credit, given the huge credit growth over the past years, rising rates compounded by accelerating price inflation will increase operating and financing costs that will crimp on profits of companies.And reduced profits will put a cap on capacity expansion. Additionally, given the limited capacity by consumers to absorb price increases, top line performance will eventually get hammered.
Moreover, surging real economy prices will mean a redistribution of consumer spending patterns, where the substitution and income effects will take hold. Higher rates will also put a brake on the credit-financedconsumer spending. This means disposable income will shrink.
We have seen this story before. [see Street Talk: Reactions of Philippine Residents to the current surge in consumer price Inflation rates Before it’s news June 16, 2014]
The ramification was for the BSP to tighten. Consequently, credit boom decelerated, money supply growth rates crashed, corporate gross sales and earnings stagnated, shopping mall vacancies emerged for the first time [See Clash of the Titans: Phisix 7,700 in the Face of a Steep Flattening of the Bond Yield Curve! February 5, 2015], real economy prices pulled back and government revenues hit a wall.
The BSP then got a cold feed over “deflation” risks.
For exactly these reasons, the BSP relaunched a record “silent stimulus” in the second semester of 2015.
Hooked on narcotic effects from sustained credit expansions, withdrawal syndromes won’t be tolerated.
Again such has been WHY the peso has reached a 10 year low. Inflationism is NO free lunch.
And given the huge capacity buildup which has been concentrated to the real estate, shopping mall, construction and hotel industries over the past few years, the impact from the reversal or even just a slowdown of credit growth should be GREATER—the second time around.
For instance, mushrooming mall vacancies has become even apparent in spite of the current sizzling rate of credit growth. Some operators have dressed this up as “renovation”. Even areas which had indeed been renovated and reopened for the last two months, tenants have yet to surface.
What more when credit growth-domestic liquidity slows? By then, CEO of Urban Outfitters, Mr. Richard Hayne’s present observation of the US retail space, as excerpted at the heading, should apply locally.
In this scenario, expect corporate balance sheets to feel the credit pressures too. Banks will also see rapid deterioration in qualities of their loan portfolios
In the same vein, current political trends, or the shift to the left, have only exacerbated present conditions.
The incumbent government strongly believes in free lunches. It has been itching to spend money. Part of which has been targeted at infrastructure projects which it believes, or at least promotes as a surefire way to economic distribution. So the government has approved USD 9.93 billion last year and has projected for implementation USD 14.6 billion this year.
Yet the beneficiaries of which won’t be the real economy, who will have shoulder the cost of such lavish boondoggles, but the bureaucracy, politicians and their cronies. Symptoms of such “crowding out effect” have already become apparent through the peso, and on the real economy as shown above.
Yet there’s more to come from such snake oil solutions.
The Philippines economy needs significantly more economic freedom, not political redistribution, financial repression and social subjugations which will only accomplish the reverse of such goals.
And when the economic slowdown becomes evident and or when a recession emerges, expect this government to undertake nationalizations. Perhaps this is the scenario when martial law will be declared. Martial law will provide the legal mantle for the usurpation of property rights.
Also, expect this government to compel the BSP to conduct even more monetization of the government’s spending.
This is the how FED actions influence the Philippine monetary environment
Dessert: Interpreting Government Data: Putting Square Pegs in Round Holes
Back to real time, it is interesting to see how government’s data resoundingly contradict each other.
Figure 3: Manufacturing Surveys, Bank Loan conditions and Job opening
The government reported January imports (+9.1%) and manufacturing (+11.6%) conditions on a tear. While exports jumped 22.5% over the same period, part of which represents output for manufacturing and indirectly for imports, such deluge in output should have offset, or at least have dampened price pressures. But apparently, this hasn’t been so.
This means that either demand has been so so so so very very very much greater than the outstanding churn rate of output from existing capacity, or that supply side growth has been vastly exaggerated. As for the former, how has this been financed?
And in contrast to government’s report, manufacturing activity in January plunged according to the Nikkei Philippines, but has partly recovered in February (upper right pane).
Even more, the BSP reported that the banking system’s manufacturing loan portfolio grew by 8.54% yoy last January, that’s way below the projected output for the sector.
For the current economy where credit growth immensely exceeds output, this would be a miracle or a wonderful sign of productivity improvement.
But this certainly would not be true given the evolution towards massive maladjustments in the real economy.
And there’s more. Manufacturing surveys have demonstrated robust increases even while real time job openings in the sector continues to suffer from a downtrend. So we are seeing jobless growth?
The conflicting message from government’s data seems like putting square pegs in round holes.
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