Devaluation means monetary expansion. The new money must enter the economy somewhere — payments to exporters, for example. The ensuing bubble is misinterpreted as a sign of the success of devaluation. But the bubble is accompanied by the well-known deleterious effects of a rising price level, income redistribution, and malinvestment. As the prices for exporters' factors of production rise and the benefits of devaluation fade away, there will be calls for more money expansion. If more than one country pursues this policy, there ensues a disastrous race to the bottom—Patrick Barron
In this issue
USD-Php Spikes to 2005 Highs! Currency Devaluation Myths, Oversold Bear Market Rally Ahead?
I. Never Believe Anything Until It Is Officially Denied: USD-Php Spikes to 2005 Highs!
II. Yen, Won, and the Peso: What Happened to the Supposed Power of FX Reserves?
III. BSP Assets: Peso Vulnerable to the Lagging Share of International Reserves
IV. Currency Devaluation Myths; No Trend Goes on a Straight Line: Expect a USD Php Pullback
V. Treasury Markets Response to the BSP’s 2nd Rate Hike: Higher Yields, Regional Underperformance
VI. Oversold Global Equity and PSEi 30: Bear Market Rally Ahead?
USD-Php Spikes to 2005 Highs! Currency Devaluation Myths, Oversold Bear Market Rally Ahead?
I. Never Believe Anything Until It Is Officially Denied: USD-Php Spikes to 2005 Highs!
Furthermore, to reduce credit risk through the exchange rate channel, the BSP has used derivatives and loans in shoring up its Gross International Reserves (GIR), thus helped in the powering up of the peso. Other Reserve assets continue to absorb a significant role in the BSP’s GIR.
…
Should a surge in global inflation continue, this massive USD short position can be expected to unwind dramatically.
*See BSP’s Diokno: No Asset Bubbles and Excessive Credit Growth; Ex-BSP Gov. Espenilla’s Minsky Moment, and Statistical Inflation of Real Estate Prices February 22, 2021
You read this only here!
Figure 1
Mainstream media has played up the incredible activities of the peso. Well, has this not been climatic? (Figure 1, topmost pane)
For the week, the Philippine peso was the weakest link in Bloomberg's roster of Asian currencies. The USD-Php spiked by 2.3%, its steepest weekly increase in years! (Figure 1, middle pane)
Interestingly, monetary officials remain in steep denial.
Inquirer, June 23: “We can see that the recent weakening of the peso along with other currencies in the region is consistent with [the] more aggressive monetary policy normalization in advanced economies, particularly the US Fed,” BSP Deputy Governor Francisco Dakila Jr. said during the briefing. Since the Philippine peso performs about average compared to its regional rivals when measured against the US dollar, Dakila claimed that external factors are the main reason for the local currency’s continued weakening. “You can see that this is more a strong dollar phenomenon rather than something that is attributable to domestic considerations,” he said.
Inquirer, June 25: The Philippine peso flirted with the 55:$1 level in intraday trading on Friday, falling to its weakest position of 54.999 against the US dollar before eventually closing at 54.985. The local currency came close to having lost two pesos against the greenback in just two weeks or 10 trading days…Despite the fast depreciation, BSP Governor Benjamin Diokno maintained that the peso remained relatively stable compared to most other currencies in the region. “This [depreciation trend] is not only limited to the Philippine peso, it is happening globally,” Diokno said. “But the BSP remains committed to a market-determined exchange rate and we intervene only to ensure orderly market conditions and prevent excessive short-term volatility in the exchange rate.”
The substantial two-week advance helped push the Year-to-Date returns of the USD-Php to 7.8%, the third-best after the USD-Japanese Yen (+17.5%), and the USD-South Korean won (+9.3%). (Figure 1, lowest window)
Year-on-Year performance shows a similar pecking order.
A slight change in rankings changed when reckoned from 2021 until last week; the Thai baht supplanted the peso for the third spot. The USD yen and the USD won remain the leaders.
The varying time perspective shows that the returns of the USD peso gained momentum only from last year through today.
Authorities repeatedly assert that factors affecting the foreign exchange rates are the relative 'stability' of the peso and external influences or developments (Fed hawkishness).
Relying on the attribution bias for its public relations (PR) management, such frameworks assume the lack of connectedness between the domestic and international economies that have brought about the peculiarities in the price actions of the peso.
In saying so, authorities betoken the inability of the markets to comprehend the 'data-driven' (historical) conditions as perceived and construed by them. To this end, they imply that the peso's fall has been a function of market failure!
Yet, despite the rhetorical flimflam, should the USD-peso continue to scale higher, the basis of their claims will only disintegrate.
Current developments only validate the axiom, "Never Believe Anything Until It Is Officially Denied."**
**See Never Believe Anything Until It Is Officially Denied: US Recession, the Stable Peso, and Stagflation June 20, 2022
II. Yen, Won, and the Peso: What Happened to the Supposed Power of FX Reserves?
Figure 2
The thing is, the peso (near its 17-year lows) joins select Asian currencies at milestone lows: the South Korean won (13.5-years), Japanese yen (24 years), and Indian rupee (all-time)! (Figure 2, topmost window)
And for all that ritualistic belief that Foreign Exchange Reserves serve as a shield against a currency meltdown, be it known that FX reserves are adrift or near record highs in Japan, South Korea, and India!
These are evidence that FX reserves are instead talismans for authorities than having a functional role against the complex untoward effects of unbridled credit expansion from an extended regime of low-interest rates.
Using the Philippine construct, it is the composition that matters.
FX reserves erected on leveraging signify "USD short" positions dependent principally on easy financial market conditions.
The reversal of the easy money conditions only exposes the veneer of strength that magnifies the risks of a looming financial crisis!
In the meantime, official policy rates have, to a certain extent, influenced the performances of these currencies.
At historical lows, the Bank of Japan (BOJ) steadfastly refuses to budge, igniting further speculations of domestic inflation.
And to defend its policy through Yield Curve Control (YCC), the BOJ has embarked on an unprecedented acquisition of the Japanese Government Bonds (JGB). Among central bank peers, the BOJ is the most daring in indulging in monetary experimentation. The BOJ is the most significant whale, controlling almost half of its JGB market! (Figure 2, middle panes)
Meanwhile, the Bank of India has also tiptoed in raising rates.
Unlike both, the Bank of Korea has serially raised rates from 2H 2021 through today. The central bank of South Korea raised a total of 125 bps.
While the global tightening of financial conditions demarcates the operational limits of the BSP to support the peso, the market's expectations of inflation served as the 'trigger' for the meltdown.
III. BSP Assets: Peso Vulnerable to the Lagging Share of International Reserves
And as expected, the BSP has hesitantly raised rates, increasing by another baby step of 25 bps this week.
And though the National Government has announced that it has partially paid back its (Php 300 billion) loans, the recent historic QE has skewed the BSP's portfolio towards domestic assets.
Operating under a de facto US dollar standard, the BSP has kept its international reserves at a steady range of 85% to 88% of its total assets, which functioned as a cap on its issuances of domestic liabilities. (Figure 2, lowest pane)
But under the pretext of the pandemic, the unparalleled emergency measures threw these limits under the bus. In March 2022, BSP asset growth has decelerated to 3.7% YoY. The massive Q1 external borrowings marginally increased the share of international reserves to 70.54% but had been insufficient to restore the gap.
This glaring chasm exhibits the extent of monetary inflation engaged by the BSP relative to international reserves, rendering the peso vulnerable to massive price dislocations.
Back in December 2021, we wrote***,
The BSP must amass sufficient FX reserves to match domestic monetary operations required to maintain the de facto US currency reserve standard. Otherwise, with inadequate FX anchor, the peso must fall.
***See External Debt Growth Accelerates in Q3! Why This Uptrend Will Continue, December 19, 2021
IV. Currency Devaluation Myths; No Trend Goes on a Straight Line: Expect a USD Php Pullback
Aside from the official spin, the consensus attempts to reason from price changes.
Figure 3
Attributing the Balance of Payment deficits may not adequately explain the tumbling peso. (Figure 3, upmost window)
BOP deficits have hardly been a factor in two crucial episodes of the rising USD-Php, specifically in 1999-2005 and 2013-2018.
Additionally, the idea that a falling peso should boost foreign revenue-dependent sectors, such as exports, tourism, BPOs, and others, is generally misleading.
One, it represents a reductio ad absurdum in defining an economy. It frames the sectors as entirely driven by exchange rate fluctuations.
For instance, following quarantine restrictions from the pandemic, the global reopening of economies compounded by government transfers has powered the recent domestic export boom. Exchange rates were barely the only factor.
Two, it disregards the comparative advantages among nations.
Three, although there may be some truth that the weakening peso may lead to growth in these sectors, this depends on the time length of adjustments. Once inflation erodes on the margins, the advantage vanishes.
As the great Ludwig von Mises explained****,
"However, this merely means that in this interval the citizens of the devaluating country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict their consumption."
****von Mises, Ludwig The Objectives of Currency Devaluation, Mises.org February 27, 2012
The PSA data on exports and the USD peso highlights this correlation. Robust export growth occurs at the onset of the devaluation, but it eventually fades. (Figure 3, second to the highest pane)
Next, the peso is on a 52-year downtrend. Did the Philippines become an export giant? Yes, if the answer is labor (OFW) exports. No, for goods. Not yet for services.
Pushing this logic to the limits, if currency devaluation or the destruction of currency is the way to prosperity, why aren't Zimbabwe and Venezuela among the advanced or wealthiest nations?
An anemic peso hasn't deterred imports too. (Figure 3, second to the lowest pane)
Part of exports depends on inputs from imports.
Also, because public spending contributes to import growth, it helps drive the merchandise deficit higher. Though increased revenues prompted a lower fiscal deficit, the public spending in the 5-months of 2022 is at a record high! (Figure 3, lowest left window)
Financed by current and future taxes (debt) and/or monetary inflation, public spending has been instrumental in fueling economic distortions, capital consumption, price pressures, and the rising peso.
For the moment, rising rates and the falling peso have yet to surface in the form of higher debt servicing costs of public debt. But the mediocre growth in debt servicing may be about the juggling of accounting. (Figure 3, lowest right window)
Four, this exacerbates the economic maladjustments, contributing to the escalation of the boom-bust cycle.
Finally, while there may be many other reasons, the more significant aspect is that currency devaluation represents a wealth redistribution scheme. Currency devaluation transfers wealth to sectors benefiting from FX revenues. It also acts as a wealth-shifting mechanism favoring borrowers at the expense of savers.
Politically induced wealth transfers lead to a lower standard of living.
With the consensus anchoring on the notion that economic growth can outrace mounting systemic liabilities, such convictions, translated into actions, ensures the path for a sustained weakening of the peso.
To close, yes, the USD Php is overbought. Plus, given the increased public apprehension, the prospect of increased interventions by the BSP in the currency market, a global countercyclical risk-on environment, and the inauguration of the new President may prompt its pullback in the interim.
No trend goes in a straight line.
Again, the latest USD-Php run reinforces the 52-year trend, which originated ironically with the regime of the president-elect's father.
Deja vu?
V. Treasury Markets Response to the BSP’s 2nd Rate Hike: Higher Yields, Regional Underperformance
Figure 4
The media fixates on the peso's dive, but we barely hear the opinions of treasury traders. Yet, through their actions, treasury traders initiated concerns over inflation. They did this not only by pushing up the yields but also by reshaping the yield curve.
The ambivalent response of the BSP, through baby steps increases in its policy rates, exacerbated the anxiety in the financial marketplace.
The media covered the selloffs in the peso and equity markets. But there was little mention of the activities in the treasury markets, where the real action lies.
It was a mixed week for BVAL treasuries.
Treasury traders continue to discount official inflation statistics, mainstream projections, and actions of the BSP.
Reflecting the second hike of BSP, yields of short-term maturities increased while bond yields, except for the 10-year, decreased. (Figure 4 topmost left pane)
The spread between the PDS 10-year yield and the official rate continued to widen, reflecting the corresponding rise in the 10-year yield, which nearly negated the rate hike by the BSP! (Figure 4 topmost right pane)
Nevertheless, the yields of 7- and 10-year bonds remain higher than the 20- and 25-year. (Figure 4 second to the highest left pane)
This back-end inversion in the treasury curve suggests that traders see liquidity problems indicating a possible economic slowdown ahead. Yes, stagflation, folks. (Figure 4 second to the highest right pane)
Unknown to most, some foreign institutions, like Nomura, have flagged the Philippines as vulnerable to food inflation. (Figure 4 second to the lowest window)
Add social risk to this, according to Allianz. Munich Germany, June 14 (Allianz SE): Net food-importing countries with a high level of social risk are the most vulnerable to social unrest in the current global environment. We identify 11 larger emerging markets that face a high risk of food-related protests in the next few years: Algeria, Bosnia and Herzegovina, Egypt, Jordan, Lebanon, Nigeria, Pakistan, the Philippines, Sri Lanka, Tunisia and Turkey. Out of these 11 countries, only Bosnia and Herzegovina and Egypt have so far embarked on consumer-oriented policies to mitigate the food price shock for households.
According to the PSA, the share of agricultural imports to total imports rose to 13.52% in Q1 2022 from 12.98% in the same period last year.
The rising share of agriculture imports accounts for the years of lack of investments due to massive resource misallocations from the low-interest rate regime of the BSP and the deeply entrenched protectionist policies of the National Government.
And even with the incoming president designating himself as the interim head of the Department of Agriculture, the political climate of this sector is not going to change anytime soon.
Circling back to the bonds, the irony is that domestic 10-year treasury yields continue to rise even as most of its counterparts in Asia posted declines.
Further, since the benchmark domestic Treasury 10-year yield outsprints its US Treasury counterpart, it reflects the variable economic and financial conditions, which incorporate the monetary stance of the respective central banks. (Figure 4 lowest window)
That is to say, the weakness in domestic bonds has diffused into the peso!
VI. Oversold Global Equity and PSEi 30: Bear Market Rally Ahead?
Figure 5
Has the bear market rally begun?
The US-led global market cap index gained USD 3.4 trillion in market cap this week. (Figure 5, highest window)
Back at home, though the PSEi 30 closed the week down 1.8%, Friday's low volume, 2.51% surge, helped by a massive pre-closing (1.03%) mark-the-close pump, could catalyze the expected sharp oversold rebound.
Both the RSI and MACD exhibit extended oversold conditions. (Figure 5, middle pane)
Furthermore, the latest slump produced a (bullish) falling wedge. Also, the PSEi 30 has strayed far from the 50-day moving average.
And in the political sphere, the financial community might participate in the inaugural ceremonies of the president-elect by bolstering the index.
Finally, the impact of inflation and interest rates on the stock markets is not mechanical. Since the millennium, the runup of the PSEi 30 came in the environment of falling rates. (Figure 5, lowest window)
The first test of PSEi 30 in the face of a rising CPI and treasury yields emerged from 2016 to 2018. Although the PSEi 30 climbed to celebrate the advent of the new President then, the stock market honeymoon lasted only for about 1-year and 1-month.
The BSP's response to the CPI and treasury yields, when it agitatedly raised rates by 175 bps in 7 months, resulted in the doldrums of market sentiment. The most affected sector from the BSP feedback was the banking system. The ensuing aversion from that reaction has guided the BSP's reluctance today.
However, like developments abroad, the BSP is raising rates as the overleveraged and overpriced PSEi 30 is on a cascade.
We are living in interesting times.