The Yield Curve Takes Control: Philippine CPI Increases to 1.3% in November

There are two kinds of statistics, the kind you look up and the kind you make up—Rex Stout from Death of a Doxy

The Yield Curve Takes Control: Philippine CPI Increases to 1.3% in November

The Forecasting Prowess of the Yield Curve; the CPI Cycle

The yield curve of the Treasury Markets, as I have been saying, presages statistical inflation. 

 

On the left of this chart is the 2012 based Consumer Price Index (CPI). On the right is the yield differential of the 10-year T-bond and the 1-year T-bill, as well as, the variance between the 1-year T-Bill and the CPI or the real yield.

The spread of the 10- and the 1-year curve has accurately foretold the direction of the 2012 CPI since the latter came to replace its 2006 predecessor in 2013.

The curve began to flatten ahead of the CPI in 2013 before the BSP raised rates in 2014. It commenced on steepening in 3Q 2015, a few months before the BSP opened the QE floodgates, pushing the CPI to reach a climax in 3Q 2018. The curve started to flatten anew before the BSP hurriedly raised policy rates beginning the 2Q 2018, whereby the CPI soon followed with a plunge. The flattening morphed into an inversion, a sign of extraordinary financial tightening, antecedent to the BSP’s chopping of policy rates, which started in the 2Q 2019. Such yield curve inversion, the first since at least 2000, is an indicator of heightened risks of a recession.   

The history of the BSP’s monetary policies can be found here.

Not only the CPI cycle, but the Philippine treasury yield curve seems to have even been predicting the crucial shift in BSP’s policy trends!

But the soothsaying prowess of the yield curve can be seen in a different light.

The yield curve, instead, projects the incumbent policies of the BSP, which drives the CPI cycle. And once the curve reaches a certain point from which the CPI follows with a time lag, treasury investors foresee and prices a turnaround on the BSP policies in response to such dynamic. The yield curve’s inflection points, thereby, represent the treasury market’s anticipation of the denouements of the peak and troughs of the CPI cycle.

Here is a truncated backstory.

In response to the tightening by the BSP in 2014, the CPI downshifted, after peaking in August 2014, for 14 straight months until it recorded two months of deflation in September and October 2015. The sharp and speedy decline of the CPI prompted the flattening dynamic of the curve to reverse in July 2015, reflecting the Treasury market’s expectation of the revival of the CPI from the BSP’s easing.

The BSP’s tightening process indeed ended with the opening of the QE spigot in the 4Q of 2015. This financial easing was supported by the record drop in its policy rates, which was implemented by the BSP in June 2016, presented under the camouflage of the adaption of the Interest Rate Corridor (IRC) System.

The yield curve steepened until it climaxed in January 2018, and four months later, in response to the surging CPI, the BSP began its 175 bps series of hikes implemented within 7-months. The CPI, meanwhile, hit a multi-year high of 6.7% in September 2018, 8-months after the curve began to flatten.

That January 2018 flattening cycle culminated with an inverted yield curve in March 2019, which from this milepost has sharply steepened to manifest the Treasury markets’ expectations of a resurgent CPI.

The BSP responded to the liquidity squeeze with a series of rate cuts, totaling 75 bps thus far, which started in May 2019, as anticipated by the curve. RRR cuts of 400 bps had also been used to ease financial tightness.

Nevertheless, because of radical political responses to the 2018 rice crisis, and statistical anomalies, if not skullduggery, the headline CPI still plunged to a 42-month low last October.

And because of the tenacious widening of the curve, which has clashed with the artificially depressed statistical inflation, confronted with a credibility dilemma, the National Government relented to publish a higher CPI last November.

Action Speak Louder than Words: Economists See No Inflation, Traders Price in Higher Inflation

 

The Philippine capital markets have a very thin participation rate from the general population. Like the stock market, the treasury market has been dominated by the financial institutions and also government financial institutions. But unlike the stock market, foreign participation may not be as significant. [Nota Bene: I’m sorry. I have no access to latest data, except to rely on old reports. Example in 2011, non-residents account for 10% share of local government bond]

As the Asian Bond Online reported in its 3Q 2019 Asian Bond Monitor: “Banks and investment houses remained the largest investor group in the Philippine LCY government bond market in Q3 2019, with an investment share slightly rising to 42.6% at the end of September from 41.9% a year earlier. Contractual savings institutions (including the Social Security System, Government Service Insurance System, Pag-IBIG, and life insurance companies) and tax-exempt institution (such as trusts and other tax-exempt entities) were the second-largest holders of government bonds. However, their share fell to 23.9% from 27.2% during the same period. The share of brokers and custodians was almost at par at 11.5% during the review period, while that of funds managed by the BTr inched up to 10.0% from 9.4%”

The treasury markets reveal the demonstrated preferences of the institutional participants or ‘action speaks louder than words’. What in-house economists and experts from financial institutions say has starkly been different compared with what their treasury departments do. Experts tell media that CPI should remain muted, but paradoxically, traders of treasury departments from these establishments don’t believe what their analysts have been saying!

And from this view, traders from various treasury departments have some indirect influence on the BSP’s policies.

November CPI Expands to 1.3% as Divergences Persist

The Philippine Statistics Authority reported that a jump in November’s CPI to 1.3%.

Curiously, despite the sustained significant deflation in the rice (-8.3%) and bread (-2.2%) CPI (-5.6%), which led to a slight -.2% deflation in Food CPI, the headline CPI still climbed! Add to this the irony of deflation in Transport CPI (-2.4%). The previous drivers of the suppressed CPI have failed to influence more downside on the headline!

What segments pushed the higher the CPI in November? According to the BSP: “The uptick in November headline inflation rate was traced mainly to higher prices of selected food items. Inflation rates for meat, fish, vegetables, as well as milk, cheese, and eggs increased in November compared to year-ago levels. At the same time, year-on-year inflation rates for rice, corn, as well as sugar, jam, honey, chocolate, and other confectionery were also less negative during the month. Meanwhile, year-on-year non-food inflation was unchanged in November as higher actual rentals for housing and upward adjustments in electricity rates due to the increase in generation charge were offset by the lower transport inflation during the month.”

As the headline inflation rose, the Core CPI slipped, the result of which has been to diminish the record divergence. Pls. see my past explanations.

[see 3Q CPI Fall to 42-Month Low as Divergences in Component CPIs Widen; Flawed CPI—the Shakey’s Pizza Evidence November 10, 2019

or here

Headline CPI at 40-month Low Diverges with the CORE; Plummeting M2’s Savings Deposits Should Spur the BSP to Relaunch QE Soon October 13, 2019]

 

The headline CPI’s November advance has been a product of the increases in its subsectors, particularly, alcohol (+17.6%), household utilities (+1.2%), furnishings (+2.8%), health (+3.1%) and communication (+.3%) relative to the previous month.

However, the bizarre disconnect between the food CPI and the restaurant CPI persisted in November. 

 

While the food CPI was less deflationary (-.2%), restaurant CPI (+2.7%) was unchanged. Hence, the record spread had narrowed slightly.  

Such statistics tell us that consumers exist in a vacuum. Consumption of food at home and food at restaurants has little human and economic connection between them.

These statistics have little relevance to the real world.

Demonstrated Preference: The BSP’s Survey on Bank CEOs

Demonstrated Preference: The BSP’s Survey on Bank CEOs

Markets versus surveys…

Banks officers have expressed sanguinity with the industry

What they said…

From the Inquirer…

The country’s top bankers expect the Philippine financial system to remain stable for the next two years, at least, with some even expecting it to strengthen, according to a new survey conducted by the Bangko Sentral ng Pilipinas (BSP).

In a statement, the central bank said that its maiden Banking Sector Outlook Survey conducted in the first half of the year showed that 66.7 percent of the respondents consider a stable outlook for the banking system while the remaining 33.3 percent view that banking system will be stronger in the next two years.

What the markets think…

 

Down 29.38% (Oct 05 2018), the Banking index has been the biggest drag to the PSE.

The banking index is a market cap weighted basket of 10 bank stocks consisting of Asian United Bank, BDO, Bank of the Philippine Islands, China Bank, East West Bank, MetroBank, Philippine National Bank, Rizal Commercial Bank, Security Bank, andUnion Bank.

If the equities represent a claim to a future stream of cash flows, then plunging prices of bank stocks have been indicative of weakness rather than strength in them. 

What they have done in the context of…

…profits…

 

…and liquidity…

 

What they have been doing to address these…

From: The Crowding-Out: Wave of Announcements for Another Round of Massive Bank Financing! The Minsky Cycle to the Minsky Moment September 23, 2018

Here are the announcements for this week alone. Security Bank published its latest exercise of raising USD 300 million from its USD 1 Billion Medium Term Note Program (MTN). And smaller peers like the Philippine Savings Bank (PSB) and the Philippine Bank of Communications (PBCOM) also announced new rounds of capital market peso financing this week.

The banking system has been diversifying funding sources for quite some time.

Bonds. Union Bank will raise Php 10 billion through a commercial and bond offering. Philippine National Bank also has Php 20 billion in the pipeline.

Stock rights.  BDO and China Bank raised Php 60 billion in January 2017 and Php 15 billion in June 2017 respectively. BPI Php 50 billion in May 2018 and Metrobank Php 60 billion in April 2018. East West Bank raised Php 10 billion last April 2018. Rizal Commercial Bank acquired Php 15 billion from the June 2018 offering. Union Bank concluded its Php 10 billion offering this month.

Long-Term Negotiable Certificate of Deposits (LTNCD). LTNCDs represent the traditional instrument.

Metrobank also announced an LTNCD program with an unspecified amount this week. Aside from this week’s announcement, PSB received Php 5.0845 billion from LTNCD issuance last August. BDO received Php 8.2 billion from LTNCD issuance in April. RCBC has a Php 20 billion LTNCD offering this September. There were many more at the start of the year.

Medium Term Notes. Aside from Security Bank which got funded by USD 300 million this month, Bank of the Philippine Islands acquired $600 million out of its target USD 2 billion programme in late August. Both RCBC and PNB raised USD 300 million each last April.

Mixed offering. China Banking raised Php 50 billion through a combination of Retail Bonds, LTNCDs and commercial papers last March.

Astonishing isn’t it? The rate of publications and announcements resonate with the hysteric coverage of inflation by media.

Demonstrated preference as described by the great Murray N. Rothbard,

The concept of demonstrated preference is simply this: that actual choice reveals, or demonstrates, a man's preferences; that is, that his preferences are deducible from what he has chosen in action. Thus, if a man chooses to spend an hour at a concert rather than a movie, we deduce that the former was preferred, or ranked higher on his value scale. Similarly, if a man spends five dollars on a shirt we deduce that he preferred purchasing the shirt to any other uses he could have found for the money. This concept of preference, rooted in real choices, forms the keystone of the logical structure of economic analysis, and particularly of utility and welfare analysis.

So let us piece together the fragmented information to get at the kernel of what bank executives have been saying. 

Banks have been struggling with their business performance since 2013, and in reaction to these, they have been aggressively raising funds from the public through various means.  

And since the funding requirement of banks abets the draining of liquidity in the financial system, and since the travails of the banking system have seen by the market participants, banks shares have been part of the recent liquidation activities.

Perhaps banks through their subsidiaries or affiliated firms have been selling shares to prop their liquidity conditions.

Perhaps, banks prefer that the public directly finance them through loans than through bidding up their share prices.

At worst, banks ask their existing shareholders, through stock rights, for funding.

That said, how does one solicit funds from the public? By presenting a bullish or a bearish outlook?

Actions speak louder than words.

Attachments area

Wow, Warren Buffett’s (Berkshire Hathaway) Cash Position Rockets by an Astounding 34%! Bullish in Words, Bearish in Action

Wow, Warren Buffett’s (Berkshire Hathaway) Cash Position Rockets by an Astounding 34%! Bullish in Words, Bearish in Action

The world’s most successful and revered stock market investor Warren Buffett has been an inveterate bull. In his 2015 letter to his flagship’s Berkshire Hathaway, Mr. Buffett asserted betting against America would be a losing proposition, “For 240 years it's been a terrible mistake to bet against America, and now is no time to start.”

In September of 2017, he made a bold and controversial claim that the Dow Jones Industrials, which was then at 22,400, would hit 1,000,000 in 100 years. However, even the mainstream media smelled the dissimulation from the Sage of Omaha’s prediction. The CAGR for the 100 year period would tally to only 3.87% compared to the CAGR of 10.7% since 2008! Mr. Buffett essentially framed the public to believe in his optimism while concealing his dampened expectations on returns!

Yet, because of his popularity, a countless number of followers has turned every Berkshire Hathaway’s shareholders meeting into the “Woodstock for capitalists”.

Mentored by the great value investing guru Benjamin Graham, the folksy Mr. Buffett has been renowned for his value investing approach

However, Mr. Buffet’s investing approach has long evolved. It has metastasized from value investing towards taking advantage of the political environment, through insider privilege and as a “champion of bailouts”, the establishment “investment moats” from politically bestowed monopolies and from the Federal Reserve’s insidious transfer policies to generate outsized profits. These practice defined in two words, political entrepreneurship.

And cronyism has reverberated on Mr. Buffett’s brand of politics. Mr. Buffet has repeatedly called on fellow billionaires to pay higher taxes. Paradoxically, Mr. Buffett’s companies have not only squared off with the IRS, they have used loopholes and accounting tricks to skirt tax payments.

Now to the heart of the story.

Striking self-contradicting insights seem to encompass Mr. Buffett’s latest bonfire for investors.

As Mr. Buffett has harped on higher taxes for the rich, he attributed the significant jump in the company’s book-value growth to Mr. Trump’s tax reform, “The $65 billion gain is nonetheless real – rest assured of that. But only $36 billion came from Berkshire’s operations. The remaining $29 billion was delivered to us in December when Congress rewrote the U.S. Tax Code” Berkshire Hathaway 2017 Annual Report p.7 

And instead of putting his words into action, Berkshire Hathaway amassed the biggest cash and cash equivalent position ever! (bold mine)

Charlie and I never will operate Berkshire in a manner that depends on the kindness of strangers – or even that of friends who may be facing liquidity problems of their own. During the 2008-2009 crisis, we liked having Treasury Bills – loads of Treasury Bills – that protected us from having to rely on funding sources such as bank lines or commercial paper. We have intentionally constructed Berkshire in a manner that will allow it to comfortably withstand economic discontinuities, including such extremes as extended market closures. (P.7)

Berkshire’s goal is to substantially increase the earnings of its non-insurance group. For that to happen, we will need to make one or more huge acquisitions. We certainly have the resources to do so. At yearend Berkshire held $116.0 billion in cash and U.S. Treasury Bills (whose average maturity was 88 days), up from $86.4 billion at yearend 2016. This extraordinary liquidity earns only a pittance and is far beyond the level Charlie and I wish Berkshire to have. Our smiles will broaden when we have redeployed Berkshire’s excess funds into more productive assets (p.9)

Wow, that’s a whopping 34% surge in liquidity that “earns only a pittance”!!!

Why? Because “economic discontinuities” may be an obstacle to Dow Jones 1 Million????

For every USD invested in stocks, Berkshire has .68 cents in cash. Or, the ratio of stocks-cash is 60-40. Total equity position as of 2017 was USD 170 billion. That’s hardly a staunchly bullish position!

And if you should notice, this hasn’t been an anomaly. Berkshire’s cash hoard has vaulted in the past 3 years, growing by 20.4% and 13.4% in 2016 and 2015, respectively.

Note from the above data, I tabulated only the cash and cash equivalent segment of the insurance business sans the rail and financials.

Given the way the market has behaved, lack of opportunities can hardly explain Berkshire’s swelling cash pile.

Shouldn’t this hoarding of cash, coming at the expense of stocks, be discerned as “betting against America”?

Or has the lessons of the Great Recession sank into Mr. Buffett? Berkshire has had little elbow room to use during the ensuing fire sale triggered by the Lehman collapse. (see above)

And interestingly, while Mr. Buffett told the public that the Dow would hit 1M, he was silently amassing cash!

Warren Buffett’s saying one thing and doing another serves as a noteworthy example of DEMONSTRATED PREFERENCE.