No country has strengthened the demand for its local currency by confiscating savings and salaries through massive increases in the money supply and confiscatory fiscal measures. It is a double expropriation of wealth—Daniel Lacalle
In this issue:
USD-Php Spike: A Trend Reversal in Favor of the USD-Php? The Strong Peso: The Emperor Has No Clothes
I. The Loose Correlation Between Surging USD and the USD-Peso Spike
II. A Bear Market Climax: A Trend Reversal in Favor of the USD-Php?
III. The USD Standard: Eroding the Stability Role of the Peso: BSP’s Falling Share of International Reserves
IV. Record GIRs Built on “Borrowed Reserves” or USD Shorts!
V. Will Broken FX-Economic/Monetary Correlations Be Restored?
VI. Conclusion: Strong Peso: The Emperor Has No Clothes
USD-Php Spike: A Trend Reversal in Favor of the USD-Php? The Strong Peso: The Emperor Has No Clothes
I. The Loose Correlation Between Surging USD and the USD-Peso Spike
The USD-Php surged by 1.48% this week to close at Php 49.2, a level last seen in July 2020 or about a year ago. Year-to-date returns suddenly turned positive from the 3.14% aggregate gains from three consecutive weeks since its lows in mid-June.
The US Dollar index (USD) rose by .4% and had been a factor in the collective weakness of the region’s currencies. Aside from the peso, the Thai baht fell 1.52%, the biggest decliner in Asia, while the Indonesian rupiah and the Indian rupee dropped .75%, respectively.
But the strength of the USD can hardly be explained by the sharp decline of the Philippine peso or the spike of the USD-Php in the context of charts and fundamentals.
Figure 1
Chart Technicals.
The uptrend in the USD emerged in the 1Q of 2018 and peaked in the 2Q of 2020. The US Federal Government’s policy response to the pandemic ended it and pushed the USD index into a three-quarter downtrend. The USD index carved a low in the 1Q 2021 or experienced a short bounce from January to April 2021 but dropped anew until May that seemingly forged a double bottom. From here, it spurred the recent rebound. (Figure 1 upper window)
At present, a second USD rally appears in the works. But it seemed to have reached overbought levels.
Let us move on to the peso or the USD-Php.
The peso bottomed and rallied in 2019, as the USD climbed, and strengthened further when the USD declined in the last three quarters of 2020. The firming peso was insouciant to the USD rally in the 1Q 2021.
That is to say, when the peso advanced (USD-Php declined) from late 2018 to the end of the 2Q 2021, the direction of the USD was largely inconsequential. Or, the USD dynamic had a minor influence on the trend of the USD Php.
In this context, a loose correlation exists between the USD and the peso. Thus, the USD's current relationship with the peso, or its supposed influence, is more of a coincidence or noise unless time proves this otherwise.
II. A Bear Market Climax: A Trend Reversal in Favor of the USD-Php?
Figure 2
The more important picture is the seeming validation of the USD-Php 2-year downtrend breakout. Not just barreling through with conviction that sent the USD-Php way above its previous resistance level, heavy volume accompanied its dramatic breakthrough. (Figure 1 lower window)
But the USD Php needs another technical confirmation. Should the previous resistance level at Php 48.7 to Php 48.9, which now functions as support, hold in the next downdraft and reflexively bounce from it, then the USD-Php is on the way up! (Figure 2 upmost pane)
Two factors identifying the target range ceiling for the USD Php: ONE, the resistance level marked by the peak of 2004-2005, and the high of 2018. TWO, the resistance of the upper channel of the USD peso from 2008. That is to say, the uptrend of the USD-Php could reach the interim or moving range of Php 54 to Php 55.50. (Figure 2 upmost window)
Even from the very long-term perspective, based on the BSP’s annual end-of-period data, the USD-Php uptrend remains intact. 2020 closed at the 39-year support. (Figure 2 middle window)
III. The USD Standard: Eroding the Stability Role of the Peso: BSP’s Falling Share of International Reserves
Most importantly, economic-financial-monetary fundamentals don’t support a sustained bid on the peso. The recent downtrend of the USD had mainly been a product of the BSP’s FX operations.
A legion of rationalizations from experts explained the recent vitality of the peso. For instance, economic weakness from the pandemic, current account balance, OFW remittances, record Gross International Reserves are among the most popular.
What’s striking has been the OFW remittance data. Despite the massive dislocation of OFWs and migrant workers, remittances were barely affected by the pandemic in 2020. The contrasting data from the BSP/OWWA/POEA suggests that the causal relations of the overseas workforce and remittances have been weak. The message to the public appears to be: To accept what authorities say regardless of the flagrant inconsistencies of data and innumeracy of logic.
OFW Unemployment versus Remittances Data: Which of the Two is Accurate or Valid? November 24
Ironically, the peso keeled even as the Philippine Government borrowed $400 million from the World Bank and $ 3 billion from the global bond markets this week. The previous external borrowing binges helped lifted the peso. But, it did not appear to work this time around. Such detachment could be a signal of a fresh dynamic on the USD-Php.
On the face of it, Gross International Reserves' headline role would seem like a critical factor.
According to the BSP, the primary function of international reserves is to provide liquidity support in times of volatility in the exchange rate and balance of payments.
But the asset segment of the BSP’s balance sheet remains dominated by international reserves.
Before 2020, FX reserves accounted for a share of 85% to 88% of its total assets. The fluctuation of FX reserves, hence, had been within a very tight range. Stated differently, the BSP ensured that the composition of its assets revolved around a fixed share of the USD reserves held.
The dominance of FX reserves showcases a de facto USD standard, which the Philippine monetary system operates on.
In this case, the supply of USD reserves functioned as an "anchor" or a "peg" that limits the domestic liquidity expansion of the financial system managed by the BSP.
But 2020 drastically altered the mix of the BSP's balance sheet!
Though the FX reserves of the BSP expanded at a historic pace, reflecting the massive debt being acquired by the National Government, its share of total assets plummeted.
As of the 1Q 2021, the % share FX reserves dived to 66.63%, the lowest in a decade at least, as BSP’s QE snared the reduced FX pie of the BSP’s assets. The % share of domestic securities and loans of advances substituted the FX’s diminished role. (Figure 2: lowest panes)
It stands to reason that the overexpansion of domestic liquidity relative to the USD-FX reserves alone points to the prospective downfall of the USD-Php, as the supply of peso immensely exceeds that of the USD threshold base.
IV. Record GIRs Built on “Borrowed Reserves” or USD Shorts!
And there’s more.
The vigor of the peso was supposed to have been bolstered by a record GIR, according to the consensus. But the propagation or the mechanics of the GIR has barely been analyzed by them.
But as earlier pointed out elsewhere, the BSP relied on FX operations, mainly from Other Reserve Assets (ORA)*, constituting financial derivatives, short-term FX loans, repo assets, non-negotiable investment funds, and long-term loans to the IMF's Managed Trust Accounts, to keep the peso strong. Data from IMF’s International Reserves and Foreign Currency Liquidity (IRFCL).
*IMF, INTERNATIONAL RESERVES AND FOREIGN CURRENCY LIQUIDITY GUIDELINES FOR A DATA TEMPLATE p.25 IMF.org
A strong peso provides tacit support to entities with significant FX debt exposure. Think San Miguel.
ORA became a critical tool for the BSP’s FX reserves management ever since the climax of the peso’s cascade or the rise of USD-Php, which culminated in 2018. (Figure 3, middle pane)
Figure 3
The peak of the USD-Php in 4Q of 2018 coincided with the BSP's buildup of ORA in its GIRs. Since this operation became part of the conventional FX management of the BSP, the use of ORAs sent GIRs to record levels. (Figure 3, upmost pane)
From next to zero before 2018, ORA reserves reached a high of 14.7% in January 2021, second only to the all-time high of 16% in December 2019.
That is to say, the recent gains of the BSP's GIRs are 'borrowed reserves' that require repayment also in FX currencies. Or, these represent 'short USD' or FX exposures.
Loose conditions from global central banks have tolerated such unsustainable dynamics. US and European junk bonds recently hit a record low. Negative bond yields deepen in Europe. Greek bond yields turned negative a few weeks back. These are evidence of the intensifying frenzy of the crowd phenomenon of blindly chasing for yields, characterized by the memes of the Fear of Missing Out (FOMO) and There Is No Alternative (TINA)!
Mistaking "low" yields as signs of confidence or a manifestation of economic or financial (current and future) strength misreads the smoke and mirror brought by the distorting activities of central bank policies.
Circling back to the ORA.
But because there are costs associated with maintaining such levered operations, the BSP reduced ORA holdings in March 2021. Instead, the BSP turned to the loans acquired by the National Government as substitutes for its 'reserves'.
From the Inquirer (July 2): Foreign borrowings and grants obtained by the Philippines to fight the COVID-19 pandemic reached $18.4 billion (about P903 billion) in June, with the bulk of which injected into the budget, the Department of Finance (DOF) said. In a report, the DOF said $16.26 billion of these externally sourced funds had been set aside for budgetary support. As of June 25, $15.6 billion of these external loans plus proceeds of offshore bond issuances were already disbursed to the government, the DOF said.
Figure 4
While the most politically convenient excuse is to use the pandemic for the spate of borrowings, the real reason for the external debt binge is to support the BSP’s balance sheets and the monetary system.
Such is the reason why in the last 5-months, public financing (Php 1.56 trillion) has almost tripled the amount of fiscal deficit (Php 566.2 billion). (Figure 4, upmost pane)
Public spending for the pandemic represents a subordinate concern.
Hence, in contrast to 2018, the recent ORA withdrawal sent the USD Php on a present downside spiral with a time lag.
Curiously, the BSP continues to lighten up on its physical holdings of gold! (Figure 3 lowest pane)
Based on the GIR, the domestic financial system is supposed to be awash in FX.
Interestingly, net foreign asset (NFA) growth continues to sizzle. NFAs of financial institutions/Other Depository Corporations (ODC) topped in July 2020 at a blazing 108.6% but have moderated to a still red-hot 34.6% in May. Meanwhile, the growth of the BSP’s NFA reached an acme of 20.6% in December 2020 but has eased to 11.8%. (Figure 4, middle pane)
But has it not been paradoxical that the FX deposit growth of the banking system has stalled even as the BSP declared recently record GIRs? What happened to all the FXs from external-NFA borrowings? Where did it flow? (Figure 4, lowest pane)
What has vacuumed the FX liquidity from the system?
V. Will Broken FX-Economic/Monetary Correlations Be Restored?
The 2-year strength of the peso has violated some important correlations.
Figure 5
For instance, the peso has ignored the inflationary effects of BSP’s monetization of the National Government through the secondary markets, aside from the public debt support by financial institutions which hit a record in May 2021. The USD Php rose when the BSP embarked on stealth QE in 2015. (Figure 5, upmost window)
Connected with it, the USD Php discounted the monetary blitz from the BSP that revved up the money supply growth as shown by the benchmark M3 from mid-2019 to mid-2020. (Figure 5, middle pane)
However, M3 growth plunged to a shocking 4.7% growth last May, an eight-year and nine-month low on the back of the historic growth dive of cash in circulation, which posted 3.9%, a ten-year low! So how is the economy being financed?
Falling M3 also suggests that the motion towards a diminishment of money supply-induced imbalances should work in favor of the peso over time. But then, can the BSP tolerate its forthcoming consequences?
Finally, the USD Php failed to keep up with the surge in statistical inflation and with it, yields of Philippine treasuries.
Will a restoration of broken correlations occur?
From the BSP’s Exchange Rate Primer (p.4): If the exchange rate movement threatens to move inflation rate outside its target range, the BSP also uses monetary measures, including adjusting the key policy rates or the interest rates it charges for its borrowing and lending activities. For example, in periods of weakening pressure on the peso, increases in interest rates tend to dampen the demand for dollars. As a result, the depreciation pressure on the peso eases.
So will a resurgent USD Php push rates higher to offset the BSP’s monetary policies?
VI. Conclusion: Strong Peso: The Emperor Has No Clothes
The crux of the matter, unless the economy generates sufficient organic FX flows (exports, FDIs, BPO revenues, OFW remittances, and tourism receipts) to settle its mounting outstanding liabilities, the toll from the artificial inflation of the peso will see a day of reckoning.
While the interventions of the BSP can only buy time, it only adds to its burdens. But since political authorities are concerned more about the immediate effects of unwanted market actions, it won’t stop them from doing so. So bi-directional volatility may be expected.
Meanwhile, any weakness of the USD relative to its OECD peers may also help in stonewalling the structural infirmities of the peso. But again, the peso’s structural deficiencies will eventually surface.
The fundamental laws of economics will prevail.
“These observers do not understand that the valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money. Thus, even the richest country can have a bad currency and the poorest country a good one.”
Ludwig von Mises, 1. Stabilization of the Monetary Unit — From the Viewpoint of Theory (1923)The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression, Mises.org
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