USD Peso Stages Breakaway Run! Correction Due; Global Liquidity Conditions, Like Deutsche Bank and Euro Money Market’s Dilemma will Play a Role

The Philippine peso was clobbered this week by 1.06% for the fifth consecutive week of losses. The USD phpclosed at 48.50 for the week.

The peso presently owns the tiara as Asia’s worst performing currency on a week on week (top) basis, as well as, year to date basis.

Malaysia’s ringgit has been the second runner-up for the week, while the peso has supplanted the Chinese yuan as tailender on a year to date basis.

 

In my view, the sharp vertical uptick of the USD php has now reached severely overbought levels and could be bound for material contraction or Newton’s law.

But since the currency markets have the tendency to be more volatile, thus Newton’s law may not be as effective as they apply to stocks. But they still apply.

History shows the way.

Over the past three years or since 2013, the USD php has spiked FOUR times.

The biggest vertical move occurred during the taper tantrum where the USD peso soared 7.4% in one monthand two weeks. Newton’s law has not appeared here.

The second leg of the USD php run had another 5.5% vertical run (on top of the 7.4%). It was here where Newton’s law emerged to erase all the gains of the second leg

But the gains from the first leg had virtually been unscathed or untouched.

Newton’s law only took the froth off the second leg but maintained the gains of the first leg which served as a staging point for the third leg.

The third leg was during the 3Q of 2015 where the USD php surged by 4%. Newton’s law reemerged but didn’t take back all of the gains.

That’s because the USD php crawled back to hit a high of 47.995 last January 26 in harmony with the downturn in global markets.

When global central banks went on a full-scale rescue of the stock market via the Shanghai accord where negative rates were implemented, this coincided with the BSP’s unleashing of the stimulus, so along with local stocks, the peso rallied.

But unlike stocks which rebounded furiously, the peso’s ascent had virtually been capped.

As I have noted here, the inverse correlation between the peso and stocks seem to have been broken. It’s only recently where the correlation seems to have been resurrected.

Present events signify as the fourth leg of the USD php upside trend. As of Friday’s close at Php 48.5, this serves as a BREAKAWAY run from the January 26 high.

Such breakaway run makes the USD php at 50 (November 2008 high) a visible horizon.

That’s most likely a target AFTER the USD corrects or sloughs off some of its overbought conditions.

Interestingly, from the close of 2012, the USD php has delivered 18.1% in returns, over the same period the Phisix generated 31.2%.

So the Phisix massively outclassed the USD php. But if I am right those fortunes will soon reverse.

Prices of exchange rates are fundamentally a product of demand and supply.

The surge in USD php has presently been from greater demand for the USD than the peso.

As I have previously observed, this may be a knee-jerk reaction, there may be a real run on the peso, and finally, the peso has been used as a political weapon by geopolitical forces.

Yet this has been happening ironically in the face of reported record GIRs

The BSP also reported its August banking system’s loan conditions as well as the liquidity conditions last week. While the bank loan growth remains substantially elevated (at 4Q 2014 levels), fascinatingly, money supply M3 has sharply decelerated to 11.8% from 13.1%.

It is as if lots of bank borrowers have stopped spending. So the funds that they have borrowed may have been used to hoard cash, pay down debt or buy USD.

And a sustained fall in M3 will likely translate to a downside trajectory for NGDP and nominal sales.

Yet even at 11.8% money supply growth remains a rapid clip. This shows the longer term supply influence of the peso to the exchange rate

 

Another curiosity, growth of government’s external debt plunged to 2.68% last August from the 6-8% range it registered during the past 9 months. Has the government raised sufficient taxes, as well as USD dollars last August enough to cover its deficits last July?

Or has the present improvement been part of the PR campaign to embellish statistics to bolster the peso and the economy’s conditions?

Lastly, not everything will be about the domestic conditions. Global factors will increasingly come into the picture.

The unfolding banking crisis in Europe will also play a big role.

So as with the surging LIBOR and TED spreads in the US (largely blamed to 2a7 reforms), the untamed China’s interbank rate Shibor, and the still ongoing problems Japan’s banking system, as well as, Saudi Arabia’s liquidity problems

It took rumors that Deutsche Bank reached a settlement with the US justice department worth $5.4 billion in fines which have been  far lower than the original $14 billion to stem the collapse in share prices last week.

Because of the massive short positions on Deutsche Bank’s shares, the rumor impelled for an intense short covering which lifted global stocks on Friday. DB soared 14.02% last Friday where the market cap was last at $17.7 billion (yahoo Finance).

And because of a holiday in Germany in Monday, regulators have become so sensitive to any potential liquidity squeezes for them to float temporary responses.

Like Wells Fargo, several employees at the Deutsche Bank have also been charged by the Italian government for creating false accounts. So aside from financial woes, impropriety will partly play a role in the coming sessions.

Rumors have been floated that DB will be rescued, but German’s media says that the German governmentwon’t do this. A bailout by the German government would set a precedent for Italian government to bailout its besieged banks, which the German government has stridently opposed. In my view, further stress in the market will force their hands. But whether the bailouts or bailins will be successful is another matter.

And anent the lingering bank and financial concerns, it’s not just DB, Germany’s second-largest bank Commerzbank announced that it would cut dividends and slash 9,600 jobs. Netherland’s largest lender, theING will also announce job cuts this week. So even banks in creditor nations of Europe are being affected.

Incidentally, USD liquidity conditions have been stretched out at the money markets in Europe such that the cost to borrow USD via cross currency swaps has risen to 2012 levels. And it’s not just in Europe, hedging cost for the USD yen also via cross currency swaps have experienced a “blowout”. These are signs of USD shortages.

The ongoing liquidity shortages have become apparent such that the Saudi Arabian government had to inject $5.3 billion into the banking system to tame surging interest rates and contain stress in her currency, the riyal. 

As the chart from the Alhambra Partners shows, the surge in US TED spread has mirrored (inverse) DB’s share prices (along with many other price signals including treasury fails) way back to 2014.

As the prolific analyst and research manager Jeffrey Snider wrote:

While attention is rightly focused on Deutsche Bank it is only so because the bank is the most visible symptom being the most vulnerable participant in this “something.” DB is just an outbreak so prominent that the mainstream can no longer pretend there is nothing worth reporting – but they can still obscure why that might be, focusing on the canard about the DOJ settlement. This is a systemic issue, one that is as plain as Deutsche’s stock price.

Liquidity risk is indicated pretty much everywhere, a direct assault not just on mainstream conventions about monetary policy but monetary competency itself.

Use any weakness in the USD to accumulate.

Philippine Peso Tumbles 1.4% the Largest Weekly Loss Since 2014; Why the Weak Peso Signifies a Long Term Trend

In this issue:

Philippine Peso Tumbles 1.4% the Largest Weekly Loss Since 2014; Why the Weak Peso Signifies a Long Term Trend

-Asset Bubbles Weakens the Currency

-Big Government Translates to Additional Pressure on the Peso

-Financing Burden on Infrastructure Spending Will Weigh on the Peso

It’s pretty much a fascination to see how the peso got clobbered again this week. The USD peso was drubbed by 1.4% to Php 47.82, the biggest weekly loss since August 2014!

 

Worst, the USD peso now trades nearly at January 2016 highs of Php 48 (Php 47.995 in specific January 26). Last January, the fumbling peso accompanied the culmination of the interim crash of the Phisix. Present conditions, as explained last week, have paradoxically departed from the recent past.

On a year to date basis, as of Friday, the USD php has yielded 1.6%

External factors surely contributed to the pesos’ infirmities, but local forces have magnified its losses. Last week, the USD firmed across Asian currencies with the exception of the yuan.

As a side note, re the yuan. While the yuan firmed last week, financial stresses in the form of skyrocketing HIBOR (Hong Kong Interbank Offered Rate) which soared to a 7 year high have emerged.  And such strains have likewise partly resonated on the mainland’s SHIBOR (Shanghai Interbank Offered Rate) overnight and 1 week rates. So if China’s policymakers have tried to “contain” offshore yuan (CNH) from a sustained fall relative to the USD by “burning yuan shorts”, as mainstream reports have suggested, symptoms of imbalances have sprouted through other channels particularly through Hong Kong and or Shanghai’s interbank rates.  Although China’s trading week was truncated by a 2 day holiday, strains on the HIBOR have surfaced even prior to last week. The PBOC even has injected “a net 385.1 billion yuan ($57.7 billion) this week, the biggest additions since April”, according to Bloomberg to alleviate mounting financial pressures. Such substantial injections have only reduced rates by some margin as rates remain at vastly elevated levels. Yet the alternative explanation may not be about the PBOC fighting off currency speculators, butabout resurgent signs of liquidity strains from “dollar shorts” in China’s banking system.

The post holiday sessions will be very interesting.

Meanwhile for this week, the South Korean won was the region’s largest loser, USD krw zoomed by 2.14%, the Malaysian ringgit came second, as the USD myr soared by 1.43% and the USD peso ranked third.

In short, perhaps part of the recent strength of the USD vis-à-vis Asia may be indicative of the reappearance of a risk OFF environment.

Asset Bubbles Weakens the Currency

But then again while external forces have influenced the peso’s weakness, local developments (past and present) have been the principal source of its underlying conditions.

 

The peso’s dilemma has hardly been a short term dynamic. To the contrary, the peso has been in a cascade since 2013!

The top window shows of USD peso’s 3 year uptrend dynamic. Such has essentially reversed the previous 4 year strong peso cycle from 2009-2012.

Actions have consequences, both in the immediate and in the longer horizon. Since exchange rates are about demand and supply, cycles are underpinned by political economic structural factors

Yet all those years of bubble blowing have repercussions. This means that the pesos’ present travails have accounted for a legacy of many years of the Philippine political economy’s reliance on credit inflation (through the BSP’s adaption of easy money policies in 2009) mainly through banking system to boost its statistical GDP. And such asset bubble blowing activities financed through credit inflation has been expressed through a massive money supply build up.

Juxtaposed with the surge of the money supply growth has been the watershed reversal of the strong peso. Remember the 10 month 30+++% M3 growth in 2H 2013 to 1H 2014? That era represented the inflection point of the strong peso. Or that year marked the first phase of the resumption of the USD peso bullmarket.

When the 30+++% M3 growth crashed in 2014 through 3Q 2015, the USD peso largely traded sideways. 

Though the USD peso began to rally in 3Q 2015, it picked up momentum concomitant with the BSP’s silent stimulus in 4Q 2015.

This tells us that sustained massive money supply growth (through bank credit inflation) will only serve to reinforce that the USD peso bullmarket.

In short, expect the peso to fall further because of the persistent malinvestments. A sharper fall by the peso is likely to occur during the unwinding stage of such malinvestments  

Big Government Translates to Additional Pressure on the Peso

And another major force would galvanize or aggravate on the weak peso trend.

Stumbling growth rates of government revenues, which surfaced in 2013, has coincided with the frail peso or strong dollar. Though fiscal deficits have hardly been a critical factor then, it will be now.

Those huge surges in M3 in 2013 and 2014 have affected both top and bottom line of many key industries. As predicted, eps conditions by listed firms at the PSE were significantly affected by these in 2015

Hence, the faltering peso has reflected on the strains on the economy brought about by bubble blowing policies, which had been vented or manifested through the decline government revenues. So falling trend in government revenues and the feeble peso has not just been a coincidence, but one of the many interdependent complex causal based relationships.

Yet the advent of the left leaning “war on everything” administration translates to the enlargement of the government. Or growth of the government will come at the expense of the private economy.

Prior to the national elections in early May, I predicted that a shift to the political left means that the government’s balance sheets will likely go wild, or will run off course:

Given that government will assume a bigger role, then this means that the rate of growth of government spending should rise faster than the economy. Therefore, fiscal deficits will only balloon

And multiple signs have been swiftly converging for these to happen soon.

Not only has the current administration been serenading the police and military forces for their support on the government’s pet “war on drugs” project, by dangling the doubling of their salaries, generally the bureaucracy will see further increases in pay and benefits. This postulates to a massive expansion in the government’s bureaucracy in terms of personnel recruitment, wages and benefits, logistics and other related expenditures etc. (therefore crowding out the private sector). Add to this would be political spending promises made by the leadership during his first SONA.

All these would accrue to a substantial ballooning of fiscal deficits via booming public expenditures.

And as baptism of fire, the first month (July) of the administration saw a material drop in government collections and a swelling fiscal deficit.

And to compound on the situation, a foreign policy anchored on rancor and antagonism enshrouds the business climate by amplifying uncertainty.

Both constitute as a lethal mix to the government’s balance sheet: Regime uncertainty—reduced confidence due to doubts on property rights—will likely upset the topline as business may have second thoughts on investing. Meanwhile, the rapid expansion in public expenditures will unduly expand on the costs or liabilities of the government which eventually would spillover to the private economy and also add to regime uncertainty. Both would account for a feedback mechanism.

Financing Burden on Infrastructure Spending Will Weigh on the Peso

Part of the promises made by the leadership at his SONA on infrastructure spending has been announced.

From the Nikkei Asian Review: (September 16): Philippines President Rodrigo Duterte has approved for auction nine infrastructure projects worth 171.14 billion pesos ($3.58 billion), including improvements at a congested airport in the capital here…Duterte is the first Philippine president from Mindanao in the south, and has promised more provincial economic development and inclusivity. He plans to ramp up infrastructure spending to 4.4% of gross domestic product next year, in line with a target to reach a 5.8% infrastructure-to-GDP ratio by 2018. Duterte's predecessor, President Benigno Aquino,awarded 12 public-private partnership infrastructure projects totaling 223 billion pesos during his six-year term, but encountered delays with both approvals and implementation. (bold added)

So in less than a quarter since the assumption of office, the incumbent will aggressively embark on infrastructure projects equivalent to 75% of previous administration’s accomplishments in the latter’s 6 years term.

You see, spending other people’s money is the easiest thing to do, especially for left leaning politicians

Of course, the public has been programmed to believe that infrastructure projects equal G-R-O-W-T-H. As I have pointed out here and elsewhere, infrastructure projects are NO free lunch elixirs. 

 

G-R-O-W-T-H will ensue, not to the general economy, but to the pockets of politicians, bureaucrats and special interest groups

Japan’s political economy is a splendid example. Japan’s politicians are frequent patrons of direct spending stimulus mostly on infrastructure. This includes the announced August 2016 stimulus by the Abe administration, which comes at the tune of ¥7.5 trillion ($73 billion) in new spending, but has a total value of ¥28 trillion over several years, according to the Wall Street Journal (see left). The new stimulus project includes “upgrading ports to accommodate foreign cruise ships and building food-processing facilities to increase exports of farm products”  

Japan has used stimulus as far back as in the 1990s when her asset bubble imploded (see right).

From then through today, the Japanese economy has been embroiled in more than two “lost decades” and wears the tiara of being the most indebted nation in the world. Yet Japan’s economy continues to wallow in stagnation. Hence the government has embarked not only on “try and try again” fiscal (mostly infrastructure) stimulus, but has experimented with the most insane monetary policy in the world—negative policy rates!

As a side note, speaking of demented policies, incidentally the BOJ will hold a meeting next week (September 20-21. The US Fed will meet too on the same days). This will be critical. Given growing doubts of the sustainability of BOJ’s large scale asset purchases (LSAP) as liquidity has virtually been vacuumed out of the marketplace, it’s been publicly floated that interest rates, instead of QE, will become key mechanism for the coming policies. Liquidity has essentially vanished in the JGB market because the BOJ has bought close to 40% of JGBs!  The equity markets have likewise been massively distorted, that’s because the BOJ has been buying equity ETFs, where it now accounts for the number one shareholder (ETF whale) in a number (55) of Nikkei 225 firms! The supposed new policy will be channeled through pushing interest rates further down negative. However, LSAPs or QEs may be reduced. This has been labeled as the BOJ’s “QE exhaustion”, the reverse “twist” or the “steepening of the curve”. 

Question is with reduced BOJ backstop on JGBs, will JGBs encounter selloffs similar to the previous week? And if does, will this spread to other negative yielding bond markets such as in Europe, where the ECB shares the same predicament in terms of diminishing inventory or “scarcity for eligible bonds” available to the ECB for LSAP? Even more, what has been relationship between the selloffs in global bonds (JGBs, EU bonds, USTs) with the spikes in HIBOR and partly in SHIBOR? What has been the connection between these and soaring US LIBOR (1 and 3 months) rates and the TED spread???  Have the latter been only from proposed rule changes as mostly attributed by media? Or have they been signaling intensifying cracks in the global liquidity spectrum on the account of realizable limits to central bank policies?

Unfolding events have truly signified as historical turning points whether in the Philippines or abroad.

Going back to the Philippines. I know the Philippines is no Japan, but they somewhat share the same sins—both have not been afflicted by household bubble but by corporate and government bubbles.

Because PPP infrastructure projects will compete with non PPP private sector for resources, where the construction industry has currently been experiencing a credit finance boom, then this entails even higher prices for infrastructure-construction related materials as well as increased wages for manpower for the industry. The government’s PSA reported steady upswing in construction material retail prices (1.5%) andwholesale prices (1.7%) for July. Thereby this postulates to the augmentation of inflationary pressures on the economy at the expense of general consumers.

PPP benefits only a small group of people in terms of employment. Based on PSA estimates as of July 2016, the construction sector employs about 8.6% of the labor force.  (The construction sector accounted for 48.1% of the industrial sector where the latter represents 17.8% of the total work force). As reminder, I bear huge reservations on the accuracy of survey based statistics. Yet not even all of the sector benefits from infrastructure projects as windfalls will fall only on the laps of the participants and their adjuncts. Despite doubts on the numbers, the point is to show of the concentration of economic bonanza to select groups

And since PPPs are the first recipient of public funds (bankrolled by credit most likely through banks or bonds), then PPPs will spend credit money at lower prices ahead of the general public (Cantillon Effect). This translates to the redistribution of benefits in favor of PPP participants, at the expense of all non borrowers and non direct PPP currency holders. Yes, that’s you and me.

Yet the supposed benefits of infrastructure output have almost always been local (where the infrastructure is physically located). And neither all local people benefit from them nor are the fruits shared equally. Said differently, some benefit more than the others. And many, if not most, people don’t.

And because such account for as a political undertaking, everyone else is hooked by the risk of failures from such undertaking. Yes everyone pays for government spending: Directly by the taxpayers; Indirectly through VAT and the INFLATION TAX.

Because these are political projects, market prices are unavailable to measure its viability. Prices are instead set by political ukase and not by demand and supply. Hence, deficits or shortcomings from such projects will be subsidized by the government—mostly through debt—or eventual reduction in subsidies to the public.

Second, infrastructure projects are not permanent. They depend on access to resources, usually provided for by easy money conditions. Once access to money becomes limited or when government balance sheets become strained, such projects would be either shelved or placed at the backburner.

If fiscal deficits blow out of proportions, which should imply of surges in interest rates, many of these feel good symbolical political projects will be either be suspended or reduced.

Consequently think of what happens to all manpower and equipment invested on for such purpose.

Japan’s try and try again fiscal stimulus depends on zero bound rates. Hence, the BoJ’s nutcase policies of pursuing negative rates.

Third, PPPs need to be financed. Question is how will all these be financed? Given the financial conditions of the list of proposed players (firms of the elites), where they have largely been cash flow deficient, then this means that such projects will be funded by credit (bank or bonds). And because these are political projects, will the government guarantee (implicit or explicit) the loans acquired by its private sector contractors? If so, then will taxpayers will be on the hook.

Lastly, since infrastructure projects are also time consuming process, impact will be diverse and dispersed across time.

The initial “benefits” will all be statistical, viz spending from PPP outlays by recipients and those attached to them, rather than real (general welfare).  The real world benefits arrive when the projects have been completed.

But the financing required to mobilize and to undertake these projects will likely mean mounting debts or increased gearing of balance sheets of PPPs firms and of the government at the onset of the projects. This shows of the intertemporal nature of effects from political infrastructure projects.

As with Japan, such showcases the massive leveraging of balance sheets or increased assimilation of risks envisaged by unclear economic bounty.

Former University of Chicago finance professor, and presently, senior fellow at the Hoover Institute John Cochrane has a very relevant insight (based on his interpretation of economist/former Harvard University chief Larry Summer’s article on infrastructure):

“Public-Private partnerships" usually mean public protection, private profits, and a piñata for politicians.”

For the Philippines, it means privatize profits, socialized losses and an even weaker peso.

A favorite mantra from fans of the administration has been that “change is coming”.

They are right, change is indeed coming. The peso will bear the yoke of C-H-A-N-G-E!

As Ellen Glasgow Pulitzer Prize winning American novelist rightly noted:

All change is not growth, as all movement is not forward