At a very high level, all the headlines are showing that commodity markets have stopped functioning since Ukraine invasion and sanctions of Russia. Whether physical, futures, financing, exchanges, etc..while no one player is systemic, the prospect of a broadening conflict will upend the whole market. With the current pile of sovereign and private debt piles, the prospect of further severe dysfunction will pressure global output further. After a long period of credit expansion, that will surely trigger systemic risk—Girolamo da Casio
In this issue
Will the Philippines be "Insulated" from the Turmoil of the Russian-Ukraine War? Authorities Panic Over Spiking Oil Prices!
I. Low (CPI) Inflation? Why are Authorities Panicking for Solutions Over Spiking Oil Prices?
II. Philippine Treasury Markets Scream Higher Inflation and Interest Rates Ahead!
III. January’s Deficits Swell on Interest Payments
IV. Will the Philippines be "Insulated" from the Turmoil of the Russian-Ukraine War?
Will the Philippines be "Insulated" from the Turmoil of the Russian-Ukraine War? Authorities Panic Over Spiking Oil Prices!
I. Low (CPI) Inflation? Why are Authorities Panicking for Solutions Over Spiking Oil Prices?
Continuing from last week…
The general idea is to keep the CPI within the targets of the BSP while providing a lifeline to the sectors bleeding from rocketing oil & commodity prices.
Price caps, from their viewpoint, represent the main policy instrument in managing the economy.
Kaboom! Transport Sector Squeeze: Fuel Subsidies, a Demand-Side Fix against the BSP’s Supply-Side Predicament? March 14, 2022
Have we not been told that the economy will stage a strong recovery in 2022?
But how can this happen if a substantial segment of the population has been severely affected by spiraling inflation?
How can diminishing earnings of a crucial sector, which has a spillover effect on the others, translate to income or wealth growth?
From the Businessworld, March 17: PHILIPPINE President Rodrigo R. Duterte rejected calls to suspend the excise tax on fuel products amid soaring pump prices, and instead approved the Finance chief’s recommendation to extend the P200 in monthly aid to poor families for a year.
From their viewpoint, the mechanical approach has always been to throw money to pacify affected groups.
So, aside from the Php 3 billion fuel subsidies or transfers, another set of monthly aid will be rationed to "targeted" groups. If the international oil prices continue to streak upwards, political demand for these subsidies will likely expand.
In reality, although there is much inflation in the economy, authorities resort to price controls and the suppression of statistics.
Proof?
Inquirer, March 17: "The Department of Transportation (DOTr) assured on Thursday that the Philippine National Railways, MRT and LRT will not impose a fare increase amid the rise in the price of oil."
While such measures may appease the public temporarily, they will lead to massive deficits in the finances of these institutions.
In that regard, public transport conditions will likely deteriorate, and capacity utilization could decrease from accelerated wear and tear and eventual breakdowns from the lack of funding.
Figure 1
And to offset part of this deficit, authorities will have to bailout the agencies by expanding subsidies. Transfers by the central government to the LRT and PNR has been rising over the past decade. (Figure 1, topmost pane)
But again, the maladjustments from price controls imply that demand for subsidies or regulation will expand to a broader segment of the political economy.
Political demand for the partial or wholesale reversal of oil deregulation or the centralization of the oil industry will also mount.
The point is: interventions beget interventions. Current subsidies lead to more transfers. Political controls will spread from one area to a broader economic spectrum.
However, imbalances mount as interventions intensify.
More importantly, as previously discussed, subsidies signify demand-side solutions to what the BSP explains as a supply-side problem.
For conservation purposes, authorities are now floating the idea of imposing a 4-day work-week. Will workers paid on daily rates not suffer? Will this not reduce productivity?
Though there are studies that show the advantages of this abridged version of work schedules, the proof of the pudding is in the eating.
Or, to capitalize on these, there would have been a widespread voluntary adaption of this operational model. Something of which has not been evident yet.
Differently put, if the said operational model is viable, political compulsion will not be required.
In any event, elevated inflation will likely reinforce the hybrid work model brought about by the pandemic.
Yet, unappreciated by the consensus is that people’s behavior will adjust to prices. The solution to high prices is high prices! (The law of demand)
II. Philippine Treasury Markets Scream Higher Inflation and Interest Rates Ahead!
The Philippine treasury markets are also the most crucial indicators of rampaging street inflation.
Weekly BVAL treasury yields have surged across the board, with the 2y to 7y posting the most gains. (Figure 1, second to the highest pane)
Neither the Fed nor the Russian offensive in Ukraine deserves the blame for an uptrend in 2y to 5y yields that started way back in 1Q 2021. (Figure 1, second to the lowest window)
Since January 2020, domestic yields have risen faster than the US Treasury counterpart. Albeit the spread, representing the Philippine premium have been rangebound since the 4Q 2020. (Figure 1, lowest window)
As emphasized here, institutional treasury traders have smelled inflation in defiance of their masters at the BSP.
A sustained rise in yields extrapolates to losses on the portfolio of treasury securities owners, mainly the banks and the financial industry.
Figure 2
Banks may be concealing such deficits Held-to-Maturity (HTM) assets, which nominal values continue to scale new record highs! (Figure 2, topmost window)
More to the point. With an economy toiling to recover from the recent slump, surging rates are likely to magnify credit risks via non-performing loans or increase systemic fragility despite the BSP relief measures. (Figure 2, second to the highest pane)
Surging rates may also dampen demand for credit. (Figure 2, second to the lowest pane)
In sum, attempts to suppress the actual extent of street inflation leads to more untoward consequences.
III. January’s Deficits Swell on Interest Payments
Intensified political demand for interventions implies higher political spending.
Figure 3
That said, the bigger picture is that public spending will continue to soar, and the cost to finance these will also spike.
The BSP adamantly insists on keeping official rates at a historic low. That is because debt servicing has also rocketed to an all-time high.
CNN, March 17: The country's budget deficit ballooned to ₱23.4 billion in January as state expenditures outpaced revenue collections amid higher national tax allotment releases to local governments, Bureau of Treasury (BTr) figures published on Thursday showed. The deficit climbed 66.3% year-on-year.
January 2022’s deficit was about debt servicing and LGU allotments.
Racing to multi-year highs, interest payments took up a substantial chunk of expenditures. In peso, interest payments are at an all-time high! (Figure 3, upper and middle panes)
Aside from growing debt stock, higher rates should increase the cost of debt servicing.
Moreover, while earmarks to the central government faded, allotments to the LGUs surged. (Figure 3, lowest pane)
LGU allocations may be about election-related spending than infrastructure.
IV. Will the Philippines be "Insulated" from the Turmoil of the Russian-Ukraine War?
Will the Philippines be insulated from the effects of the Russian-Ukraine war?
We shall start with a few excerpts.
From Bloomberg/Financial Post, March 18: It’s getting harder to deal in some of the world’s most important commodities as everything from geopolitical turmoil to exchange snafus prompt traders to rush for the exits, rapidly draining liquidity. Prices of materials like crude, gas, wheat and metals have become alarmingly erratic as a gulf emerges between buyers and sellers who are facing big financing strains. Markets have been roiled on fears about Russia’s invasion of Ukraine constraining commodities flows, though in many cases rallies were quickly followed by a drop in prices. The London Metal Exchange’s embarrassing weeklong suspension of nickel trading is an example of a market grinding to a halt after extreme price moves. Liquidity is nonexistent as some dealers try to close positions amid a glitchy reopening of trade in the critical metal. The volatility is particularly difficult to navigate because some moves appear to defy fundamentals, with hedge funds exiting long-term bullish bets just as supply looks the tightest in years. Merchants are finding it harder to snap up any cheap cargoes because of huge margin calls and credit line caps.
Marketwatch, March 16: A trade group representing Europe's largest energy traders asked governments and central banks for emergency assistance, warning of a cash crunch resulting from commodity-market volatility following Russia's invasion of Ukraine, the Financial Times reported Tuesday. In a letter, the European Federation of Energy Traders, whose members include BP, Shell and commodity traders Vitol and Trafigura, said there was a need for "time-limited emergency liquidity support to ensure that wholesale gas and power markets continued to function," the report said. The letter was dated March 8 and sent to market participants and regulators, the Financial Times reported.
Moneycontrol, March 09: Credit Suisse short-term rate strategist Zoltan Pozsar, a former United States Federal Reserve and US Treasury Department official, in a report said the US is in a commodity crisis and this will give rise to a new world order that will weaken the US dollar and create higher inflation in the western world. Here are the key takeaways from his note titled Bretton Woods III — We are witnessing the birth of Bretton Woods III – a new world (monetary) order cantered around commodity-based currencies in the East that will likely weaken the euro-dollar system and also contribute to inflationary forces in the West. — A crisis of commodities is unfolding. Here commodities are collateral, and collateral is money, and this crisis is about the rising allure of outside money over inside money. Bretton Woods II was built on inside money, and its foundations crumbled a week ago when the G7 seized Russia’s FX reserves.
Bloomberg/AJOT, March 18: Spain’s construction industry risks coming to a halt and collapsing due to a five-day long truckers protest over fuel prices. The situation is “extremely serious” for the entire concrete industry, including quarries, plants and transportation, five industry groups said in an emailed statement Friday. In various regions, including Madrid and Andalusia, the production of concrete has stopped completely due to the demonstrations, according to the statement.
The massive disruption of the division of labor through economic and financial sanctions, trade discrimination, trade cancellations and suspensions, and more is affecting the global commodity markets from physical to distributional to the financial sphere spectacularly!
Figure 4
Skyrocketing energy prices in Europe has not only been hurting consumers but also forcing several highly affected industries to cut back on operations and output, thereby exacerbating global supply issues. (Figure 4, topmost window)
Amplified bi-directional volatility of commodity prices has caught many leveraged firms on the wrong footing. For instance, the Hong Kong (China) owned London Mercantile Exchange (LME) suspended the nickel market for a few days when one Chinese tycoon Xiang Guangda’s Tsingshan Holding Group, got burned from shorting the metal.
The contagion on the oil markets has percolated to the oil futures, depressing market liquidity, thereby magnifying volatility. (Figure 4, middle pane)
On the heels of excessive volatility and the accompanying losses, the commodity industry has appealed to the central banks for liquidity support.
Because assets of the commodity sector constitute part of bank collateral, the liquidity crunch has also filtered to market perception of bank credit risks. In turn, the default risks of US and European banks have also climbed. (Figure 4, lowest pane)
The degree and channels of impact are unclear yet on insurance, re-insurers, and non-bank financials.
There will also be workarounds and consequences from the sanctions imposed against the central bank of Russia.
Yes, last week’s performance transformed into liquidity versus fundamentals.
Figure 5
As noted before, the obsession with ESG has prompted low investments in traditional fuels. As such, crude oil inventory has dropped to multi-year lows. (Figure 5, topmost window)
Meanwhile, the US government's Strategic Petroleum Reserve nears depletion from sustained drawdown. (Figure 5, middle pane) At the same time, US coal production has barely recovered. (Figure 5, lowest window)
Figure 6
Surging energy prices, de-globalization, economic sanctions, labor and supply disruptions from the pandemic and protectionism, as well as, the Russia Ukraine war, have also fueled a spike in US fertilizer prices. (Figure 6, second to the highest pane)
Chinese farmers are increasingly concerned about the emerging scarcity of fertilizers. (Figure 6, topmost pane)
Concerns of a food crisis have emerged in Lebanon, Egypt, and parts of the Middle East and North Africa due to mounting wheat shortages.
Aside from the above, transit bottlenecks have also spurred increases in US shipment costs of grains. (Figure 6, second to the lowest pane)
The emergence of the avian flu in the US may also affect chicken and egg production and supply.
Again, the price spikes due to supply and demand imbalances are not limited to energy and food. Russian-Ukraine war has exacerbated the production and supply of semiconductor chips mainly through the tightening supplies of neon gas, xenon, and krypton, which both warring parties signify as principal suppliers. Think of the daisy chain consequences from the possibility of a chip shortage on mobile phones, PC and laptops, and other electronic devices globally.
Because of the spontaneous interactions of the billions of people, complex dynamics translate to overlapping feedback loops, which are can hardly be modeled by statistics. Besides, human action is forward-looking, statistics represent history.
Like the Philippine government, the International Energy Agency (IEA) proposes a 10-point plan to cut oil demand by slashing traffic mobility, including reduced work-week, car-pools, car-free days, force adoption of Electric Vehicles, and more.
Oddly, traffic restrictions appear to be a common denominator between the still present COVID and the commodity crisis.
In any case, only a massive recession, which implies demand destruction, will likely alleviate the imbalances in the oil and energy sector.
Finally, the US FED timidly raised rates last week, which means credit conditions will remain accommodative in the face of massive supply constraints, perhaps adding fuel to the raging inflation.
Good luck to those who believe that the impact of the Russia-Ukraine war on the Philippines will be limited.
Yours in liberty,
The Prudent Investor Newsletters
