I have used all my life a wonderfully simple heuristic: charlatans are recognizable in that they will give you positive advice, and only positive advice, exploiting our gullibility and sucker-proneness for recipes that hit you in a flash as just obvious, then evaporate later as you forget them—Nassim Taleb
In this issue
2014 Prediction Fulfilled: Philippine Yield Curve Inversion Spreads! US Yield Curve Inverts Too! Global Recession Countdown Starts
-Philippine Treasuries: The Deepening Yield Curve Inversion!
-Feedback Loop: Banking Problems Ventilated through the Yield Curve and Vice Versa
-Inverted Curves: Philippines Close to Joining Mexico, Canada and the US; US Fed Powell’s U-Turn Aggravates Inversion Dynamics!
-Inverted Curves Equals a Countdown on Recession!
-Sharing the Inverted Curve: Will the Philippines Be Immune from a US Recession?
2014 Prediction Fulfilled: Philippine Yield Curve Inversion Spreads! US Yield Curve Inverts Too! Global Recession Countdown Starts
Philippine Treasuries: The Deepening Yield Curve Inversion!
The public remains stunningly oblivious to the escalating cracks behind the masquerade of a massive credit-fueled boom.
Even before the BSP announced that it would keep its policy stance, the Philippine treasury market has continually opposed the positive signals sent by the domestic stock market.
Yet, the trend of the collapsing yield curve has only been accelerating!
Figure 1
First, the yield curve inversion brought about by Treasury notes.
The yield of the 1-year notes closed higher across the curve or through the 20-year bond (PDS data). Based on the official BVAL benchmark, it was higher across the curve through the 10-year bond. (Figure 1, upper window)
Though yields have been dropping on notes and bonds, this INVERSION dynamic has been the result of the faster and deeper decline of the longer-end than the shorter-end.
Next, Treasury Bills closing in fast on notes and bonds!
And despite crashing headline statistical inflation, yields of the 1-month T-Bills, and now joined by 3-month T-bills which have reached January 2019 levels, are at multi-year highs! (Figure 1, middle window) Should the current dynamics persist, the 10-, 20- or even 25-year yields may fall BELOW such level!
As I have been saying here, the stubbornness of the T-Bill yields, which curiously have been included by the BSP for its Open Market Operations, have been symptoms of intensifying liquidity drought plaguing the banking system.
Bluntly put, the BSP has lost control over yields of T-Bills!
The intensifying liquidity strains have expanded to collapse even the 20-year spread which has also inverted against the 1-year and 2-year notes.
The spread between the yield of the 6-month T-Bill and the 10-year and the 20-year bonds has fabulously flattened to a paltry 20.6 bps and 3.5 bps!
Feedback Loop: Banking Problems Ventilated through the Yield Curve and Vice Versa
Since banks operate on the principle of the maturity transformation or Banks borrow short term (deposits), lend long term (make loans, buy securities), yield curve inversions tend to magnify the “maturity/duration mismatch”, that is, pay short-term (floating) rate, receive long-term (fixed) rate.
With higher costs on short-term liabilities than the lending rates for the longer term, margins shrink or could even turn into losses, thereby discouraging banks from issuing loans.
And as short term rates continue to rise, the acquisition for funds by the domestic banking industry has shifted to bonds and stock rights.
This March, the Philippine Savings Bank [PSE: PSB], and the Philippine Business Bank [PSE: PBB] announced bond issuance programs worth Php 40 billion and Php 10 billion respectively.
For a credit dependent economy, what happens when banks reduce making loans to the public?
Figure 2
The collapsing yield curve didn’t emerge from a vacuum; the curve rolled over even before the BSP raised rates in May 2018.
Asian Development Bank’s favorite benchmark the 10-year 2-year spread has inverted, for the first time since at least a decade!
Bank stocks, as measured by the PSE’s banking index, appears to have undulated along with the gyrations of the ADB benchmark (10-year/2-year).
When the benchmark spreads narrows or flattens, the bank index follows. Such has been the correlation of both variables since the 4Q of 2014.
Recently, bank stocks have diverged from the collapsing curves.
PSYEi 30 Bank stocks have been “forced” higher to propel the index upwards.
Apparently, someone persuaded the newly installed BSP Governor that easing may not be the wisest thing to do.
Inverted Curves: Philippines Close to Joining Mexico, Canada and the US; US Fed Powell’s U-Turn Aggravates Inversion Dynamics!
One of the global benchmarks for the yield curve is the 10-year/3-month spread.
Figure 3
Though the 10-year/3-month curve has been crashing too, the spread remains a slight positive 20.6 bps.
And the Philippines have landed in a page of the international elite. The Philippines was ranked eighth in terms of inverted or flattest spread!
The Philippines is close to joining Mexico, Canada, and the United States with an inverted curve from the 10-year/3-month basis.
The full inversion of the US yield curve has been brought about partly by the capitulation of the US Federal Reserve Chairman Jerome Powell.
Having downgraded their U.S. growth, unemployment, and inflation forecasts, noted the Reuters, the U.S. Federal Reserve brought its three-year drive to tighten monetary policy to an abrupt end, abandoning projections for any interest rate hikes this year amid signs of an economic slowdown, and saying it would halt the steady decline of its balance sheet in September.
Interviewed by Reuters, bond sage Jeffrey Gundlach, chief executive of DoubleLine Capital bewilderedly remarked, “This U-Turn - on nothing fundamentally changing - is unprecedented…Three months ago, we were on ‘autopilot’ with the balance sheet - and now the bond market is priced for a rate cut this year. The reversal in their stance is stunning.”
By throwing in the towel, the FED has fundamentally acknowledged the following: First, it has overstepped its tightening. Second, the US economy cannot handle 2.25% to 2.5% interest rates. Third, stock markets actions have dictated their policies. Fourth, they have NO clue of what they have been doing, and finally, with limited room for interest rates cuts, the door for QE 4.0 has been sprung wide open!
Inverted Curves Equals a Countdown on Recession!
Figure 4
The Fed’s policy tools have even malfunctioned.
The Effective Federal Funds (EFF) has risen above the Interest Rates on Excess Reserves (IOER) for the second straight day. (figure 4 upper window)
You can ignore small twists and brief turns in them, but persistent and worsening distortions are very clear signs. Escalating warnings.
While EFF remains above IOER, the entire middle section of the UST curve is under it; several maturities including the 5s are less than the Fed’s RRP “floor” today! Things are really getting screwy.
Not only has the yield curve been in full inversion but the Fed’s inflation platform has been thrown askew.
As I have pointed out last January, the association between inverted yield curves and recessions have been strong. [See The Biggest Warning Yet! Clue: Not the Hanjin Default January 13, 2019]
The linkages between inverted curves and recessions have also been causal.
“What does an inverted yield curve indicate? This: the expected end of a period of high monetary inflation by the central bank, which had lowered short-term interest rates because of a greater supply of newly created funds to borrow.
“This monetary inflation has misallocated capital: business expansion that was not justified by the actual supply of loanable capital (savings), but which businessmen thought was justified because of the artificially low rate of interest (central bank money). Now the truth becomes apparent in the debt markets. Businesses will have to cut back on their expansion because of rising short-term rates: a liquidity shortage. They will begin to sustain losses. The yield curvetherefore inverts in advance.
“On the demand side, borrowers now become so desperate for a loan that they are willing to pay more for a 90-day loan than a 30-year, locked in-loan.
“On the supply side, lenders become so fearful about the short-term state of the economy -- a recession, which lowers interest rates as the economy sinks -- that they are willing to forego the inflation premium that they normally demand from borrowers. They lock in today's long-term rates by buying bonds, which in turn lowers the rate even further.
“An inverted yield curve is therefore produced by fear: business borrowers' fears of not being able to finish their on-line capital construction projects and lenders' fears of a recession, with its falling interest rates and a falling stock market.
“An inverted yield curve normally signals a recession, which begins about six months later. The stock market usually begins to fall six months prior to any recession. So, the appearance of an inverted yield curve normally is followed very shortly by a falling stock market. Fact: The inverted yield curve is an anomaly, happens rarely, and is almost always followed by a recession.
With the exception of 1965 to 1967, an inverted curve has signaled most US recessions. (Figure 4, Middle window)
From the Federal Reserve Bank of Cleveland wrote: “The rule of thumb is that an inverted yield curve (short rates above long rates) indicates a recession in about a year, and yield curve inversions have preceded each of the last seven recessions (as defined by the NBER). One of the recessions predicted by the yield curve was the most recent one. The yield curve inverted in August 2006, a bit more than a year before the current recession started in December 2007. There have been two notable false positives: an inversion in late 1966 and a very flat curve in late 1998.” (bold mine)
So the probability of a US recession rises!
Sharing the Inverted Curve: Will the Philippines Be Immune from a Global Recession?
Will the Philippines be immune to a US (or global) recession in 2019 or 2020, considering that she shares the same malaise with the US?
The Philippines almost fell to a recession during the 2008 Great Recession or the Financial Crisis of 2007 to 2008. GDP slumped to a low of .5% in the 3Q of 2009. It took a massive series of interest cuts to the tune of 350 basis points from 7.5% (July 2007) to 4.0% (July 2009) and an economic stimulus project, mainly infrastructure based, called the Economic Resiliency Plan (ERP) worth Php 330 billion or 4.1% of the GDP to forestall it.
With today’s emergency measures still in place, viz. policy rates are close to the 2009 levels and 2016 historic low of 3%, QE remains at record and infrastructure (build, build, build) powered fiscal deficit, what economic and financial policy tools remain for the National Government to use for such contingencies?
And do notice, the correlation between the 10-year UST and Philippine counterpart has been strong too. Recent events point to UST yields falling faster than the Philippine equivalent. So will Friday’s plunge in the yields of USTs be reflected in the domestic market this week?
Though the BSP hasn’t moved on interest rates, it will soon. Oh, changes in Reserve Requirement Ratios are announced separately from the settings of the Monetary Board (February and May 2018). RRRs cuts can be expected anytime soon to plug the banking system’s liquidity cesspool.
Once data exposes the developing economic weakness from the ongoing liquidity crunch, the Fed Chair Powell’s recent reaction can be expected to be replicated by the BSP!
In consternation, the BSP will not only chop rates, but it will accelerate money printing via QE!
As a reminder, back in 2014, I wrote this: (bold original)
An inversion will likely occur when a credit crunch has become evident….
Yet the feedback loop between accruing losses and increasing credit strains will extrapolate to higher demand for short term loans which should drive short term yields to even higher levels relative to the longer end.
If such dynamic is sustained then this will eventually lead to a yield curve inversion. The inversion will now signal a recession, if not a crisis!
My yield curve inversion prediction has been fulfilled!
A recession countdown is next.
Buy the USD-Php as insurance! (The USD Peso experienced a marking the close last Friday!)
No comments:
Post a Comment