The USD Php at 50 and the FED

The USD-Peso broke beyond the 50 level for the second time this year.

 

Mainstream media and officials tell the public that this had mainly been due to the “hawkishness” by the FED.

But financial markets are supposed to be anticipatory.

The US FED has raised rates THRICE in the last seven months (December 2016, March 2017 and June 2017), yet the USD-Php hardly reacted in the way it should IF it were truly the FED that had mainly driven it.

And such domestic reaction has further been amplified by the region’s performance.

 

While it may be true that most of the region’s currencies were weaker this week (upper left chart), it seems hardly the case where the FED’s string of tightening measures had led to a stronger USD (upper right chart).  

In fact, Asia’s “race for yields” where the region’s stock markets have caught fire appears to have contradicted the FED’s actions.

A FED tightening, theoretically, should have filtered into the region’s currencies, and likewise, should haveconstricted such yield chasing phenomenon.

But that’s not what has been happening.

Instead, Asian currencies have firmed up and have fueled stock market levitations in the region (bottom chart).

And it has more than just been stocks.

There has been a record issuance of Asian perpetual bonds at extremely low coupon yields. A Bloomberg article notes that this may signify “Flash Risk Warning for Asia”. Also, demand for Asian junk bonds have also been on fire (yes at record too), where bond investors are supposedly “sacrificing safeguards in their chase for yields”

In other words, financial markets have largely ignored the FED’s actions and perceive the current environment as undergoing further easing.

It’s a case of self-reinforcing feedback mechanism between profusions of liquidity spawning speculative excess and vice versa.

As a side note, in the US, market actions have defied the FED: there has been a massive flattening of the yield curve, Commercial Industrial loan growth has also slumped to 2% in May, oil prices have dropped to below $45 ($43.01) and commercial real estate prices appears to have peaked. All these in the face of record high stocks!

This brings us back to the peso.

The FED has been tightening alright, but the BSP last week maintained its record lowest rate in history. Naturally, such policy asymmetry should entail that the peso should weaken. And inflation strains from these would mean that the BSP would eventually have to tighten.

In addition, the government’s fiscal data showed that fiscal deficits ballooned to Php 33.421 billion last May.

Whether the month’s deficit has been financed by borrowing from the credit markets or by the BSP’s monetization, we will find out as soon as the data gets published.

If financed by the BSP, which is inflationary, then the peso’s current conditions may reflect on such actions.  It would not be the case if the government financed this through the debt markets.

As previously explained, the BSP bankrolled the government’s record deficit in 2016. Yet to constrain real economy price pressures, the government shifted to debt financing early this year. (Oh My, Has the BSP Commenced on Tightening??? June 4, 2017)

Outside the BSP, it is the banking system that principally determines the liquidity conditions.

The point here is that although the FED does play a role, domestic policies mainly determine the exchange rate conditions.

I remain bullish the USD Php.

 

And, if there should be an external force contributing to the USD Php, it looks more about the yuan whose correlations with the USD-Peso have strengthened since 2014

My guess is that lots of dollar sourcing and flows into the country may have emanated directly or indirectly from China.

 

With the USD peso at 50 compounded by the week’s mitigated correction, the above represents an update of the Phisix priced in USD.

Yellen’s Most Dovish Rate Hike

The US Fed hiked interest rates for the second time in three months last week

But instead of a perceived tightening, the perception of a dovish rate hike prompted for a decline of the USD which combusted global risk assets.

Alhambra’s Joseph Calhoun handily wins the quote of the week: The market was starting to price in four (today’s plus two more) and that had to come out of the market after the meeting. This was the most dovish rate hike in the history of rate hikes. Greenspan’s old conundrum was that long term rates weren’t rising as the Fed hiked. The conundrum today is that even short term rates aren’t rising as the Fed hikes. Two year note yields are right back to where they were after the December rate hike. 

Ms. Yellen actually poured oil into the fire when she said: “Even after this increase, monetary policy remains accommodative, thus supporting some further strengthening in the job market and a sustained return to two percent inflation”

She also introduced the word “symmetric” in the FOMC statement which meant flexibility in their inflation targeting: “And it's a reminder, 2 percent is not a ceiling on inflation. It's a target. It's where we always want inflation to be heading. And there will be some times when inflation is above 2 percent, just like it's been below 2 percent. We're not shooting for inflation above 2 percent. But it's a reminder that there will be deviations above -- above and below when we're achieving our objective.”

I have recently opined that the likely reason for the rate hikes may hardly be due to the reading of statistical tea leaves like output gaps but rather that the Fed behind the curve. [Has the Fed “Fallen Behind the Curve”?(March 11, 2017)]

From the perspective above, it’s easy to see the likely factors or influences that may have altered the perspective of the majority officials of the US Federal Reserve.

If the FED has indeed been behind the curve, timid rate hikes will only further bolster the underlying risk appetites.

And Ms. Yellen’s observation that this may “potentially require us to raise rates rapidly sometime down the road” may become self-fulling prophecy.

This is what I meant by falling behind the curve.

Instead of impeding further ramps in asset prices, half-hearted rate increases serve only to accelerate a feedback loop.  In 2004-2006, the Fed raised rates by 17 times! Yet prices of property and the S&P escalated further. US housing prices topped a few months before the Fed’s last rate hike.

In sales, this would be equivalent to “selling a price increase”. In anticipation of a price increase, buyers would buy more quantity of items than they would under normal circumstances. By the same token, timid rate hikes, instead, whet the people’s appetite to load up on debt which they use to chase after asset bubbles. That’s what happened during the last credit cycle which ended with the Lehman bankruptcy.

Yet in the previous cycle, the FED raised rates about four years after (or in 2004) it began cutting rates in 2001 in response to the dotcom bust.

In the current cycle, the Fed hiked rates in late 2015, seven years after it began to slash rates in 2007 in response to the Great Recession.

Seen from the context of the S&P, the first time the Fed increased rates the bull market was only 1 and a half years old or at its first leg.

In the current setting, the Fed increased rates in December 2015 when the bullmarket was about 7 years old!

The point here is that modern day central banks are afraid to take the proverbial punch bowl away because of they are in mortal dread of debt deflation. Debt signifies a monster which they have created, which ironically, they have been afraid to confront.

Yet the question is if the aging US bullmarket would still have the stamina to carry through amidst the tremendous amount of malinvestments that have been acquired or accumulated through the years.

As I have been pointing out here, near vertical record US stocks has been founded from increasing questionable quality. It has been practically been pillared on hope backed by rationalizations and by the herding effect predicated on the fear of missing out.

In the 4Q US flow of funds, US stocks were driven secondarily by corporate buybacks and primarily by retail investors who chased after passive funds.

Here’s Mr. Ed Yardeni with the details:  (bold mine)

(1) Supply-side totals. Net issuance of equities last year totaled minus $229.7 billion, with nonfinancial corporate (NFC) issues at -$565.7 billion and financial issues at $269.7 billion. The increase in financials was led by a $283.9 billion increase in equity ETFs, the biggest annual increase on record. The decline in NFC issues reflected the impact of stock buybacks and M&A activity more than offsetting IPOs and secondary issues. 

(2) Demand-side total. To get a closer view of the demand for equities, let’s focus now on the quarterly data at an annual rate rather than at the four-quarter sum. This shows that equity mutual funds have been net sellers for the past five quarters, reducing their holdings by $151.3 billion over this period. Over the same period, equity ETFs purchased $266.4 billion, with their Q4-2016 purchases a record $485.4 billion, at a seasonally adjusted annual rate. Other institutional investors have been selling equities for the past 24 consecutive quarters, i.e., during most of the bull market! Foreign investors have also been net sellers over this same period. 

So smart money sold while retail investors piled in.

The normally bullish Mr. Yardeni concluded: “The bottom line is that the current bull market has been driven largely by corporations buying back their shares, as I have been observing for many years. More recently, we have been seeing individual investors increasingly moving out of equity mutual funds and into equity ETFs.Both kinds of buyers tend to be much less concerned about historically high valuation multiples than more traditional buyers are. We may be witnessing the beginning of an ETF-led melt-up, which may simply reflect individual investors pouring money into passive stock index funds. Lots of them seem to bemore interested in seeking out low-cost funds rather than cheap stocks. In this case, valuation multiples would lead the melt-up, until something happens to scare investors out of those passive funds, which could trigger either a correction or a nasty meltdown. It is obviously a bit late in the game to start only now to be a long-term investor given that stocks aren’t cheap no matter how valuation is sliced and diced.”

And there’s one thing I forgot to mention last week.

The US treasury injected hundreds of billions of funds into the system in anticipation of the expiration of the US debt ceiling last March 15 from the start of the year. Since this has almost been similar to a credit easing, this may have driven the record-breaking “Trump bump trade”. Unfortunately, this is a liquidity illusion. The first reason: the Fed’s hiking cycle would mean trimming of excess reserves in the system. The next reason is that when the debt ceiling will be lifted, the US treasury will likely sell huge amounts of debt into the system which means it would entail draining a lot of liquidity in the system.

 

And just how will a drain in liquidity impact the already pressured US retail industry led by the restaurant and the department stores? Retail sales grew at the weakest pace in 6 months last February.

Even worst, credit instruments to shopping malls seem as Wall Street’s next biggest shorts!

From Bloomberg (March 13, 2017):

Wall Street speculators are zeroing in on the next U.S. credit crisis: the mall.

It's no secret many mall complexes have been struggling for years as Americans do more of their shopping online. Now they're catching the eye of hedge-fund types who think some may soon buckle under their debts, much as many homeowners did nearly a decade ago.

Like the run-up to the housing debacle, a small but growing group of firms are positioning to profit from a collapse that could spur a wave of defaults. Their target: securities backed not by subprime mortgages, but by loans taken out by beleaguered mall and shopping center operators. With bad news piling up for anchor chains like Macy's and J.C. Penney, bearish bets against commercial mortgage-backed securities are growing.

Wow, if US shopping malls become the epicenter of a crisis, this will likely spread across the globe the world! Guess what would happen to Philippine malls???

As a final thought, it wasn’t just the FED that hiked rates. Countries which had their currencies pegged to the USD like Hong Kong, UAE and Kuwait raised interest rates. China’s PBOC raised rates on repos (open market operations) and medium lending facility 10 hours after the FED hiked. While the BOJ kept policy unchanged, rumors floated of a “stealth tapering” where the BoJ would miss hitting its annual LSAP targets.

With global stocks on a tear as liquidity is being withdrawn, just how sustainable can this environment be?

As a final note, the Geert Wilders, the far-right contender lost the Netherland’s national elections last week.