Credit expansion is the government’s foremost tool in their struggle against the market economy. In their hands is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous—Ludwig von Mises
In this issue
Bank Bailout: BSP Retains Policy Rate; Hello Stagflation! Fastest Plunge of Treasury Spreads (20 & 5 years) Since 2014! PSE Bank’s 3Q Performance
I. Fact or Misinformation? Is the BSP Responsible for Setting Interest Rates?
II. Philippine Treasury Markets: Hello Stagflation! 20-5 Years Spread Fastest Plunge Since 2014!
III. Philippine-US Treasury Yield Differentials Exhibit Domestic Vulnerabilities
IV. BSP Subsidy: Suppressed Interest Rates Equals Reduced Bank Cost of Funds; The Evidence: PSE banks
V. BSP Subsidy: Inflation Tax Benefits Borrowers (Government, Banks and Elites)
VI. Magic of the BSP’s Bailouts: Despite Twin Deficits on Core Operations, Bank Profits Boomed!
VII. Magic of the BSP’s Bailouts: Despite Twin Deficits on Core Operations, Bank Profits Boomed!
VIII. BSP Bailouts Swells Bank and Financials Share of GDP!
Bank Bailout: BSP Retains Policy Rate; Hello Stagflation! Fastest Plunge of Treasury Spreads (20 & 5 years) Since 2014! PSE Bank’s 3Q Performance
I. Fact or Misinformation? Is the BSP Responsible for Setting Interest Rates?
The BSP announced that it is keeping its stance on monetary policy.
From CNN, November 18: The Bangko Sentral ng Pilipinas kept interest rates at their record low again this November in a bid to spur borrowing activity and give the economy a boost. …The central bank's rates serve as a benchmark for pricing loans, and credit card and deposit rates for banks and lending firms. "The Monetary Board maintains that keeping a patient hand on the BSP's policy levers, along with appropriate fiscal and health interventions, will keep the economic recovery more sustainable over the next few quarters," the BSP chief said.
This assertion represents an example of the presumptuous quality of information from the so-called guardians of factual information.
The excerpt attempts to show the causality between monetary policies and credit transactions operating under the assumption of the complete dominance of BSP’s arbitrary policies.
However, it fatally neglects the role of capital markets and the market economy.
Since credit is its primary source of financing, it is further supposed that the BSP is responsible for driving the modern economy.
By extension, further presumed from this claim is that the BSP is an omniscient entity that can only make the right decisions.
Ironically, if the assertion is valid, why then has the BSP not abolished interest rates? And if central banks do possess such power, why have accounts of hyperinflation not vanished?
Figure 1
Contrary to the above, we argue that Treasury markets serve as the benchmark for banks, reflecting activities of the real economy, which the BSP attempts to manage with its policies.
II. Philippine Treasury Markets: Hello Stagflation! 20-5 Years Spread Fastest Plunge Since 2014!
At present, the BSP seems seriously way behind the curve. That is, the deviation between the yields of the Philippine Treasuries and the BSP’s policies have only been escalating. For example, the 10-year yield of domestic Treasuries has ascended since January 2021, despite the unprecedented lows of BSP monetary policies. (Figure 1, upmost pane)
Or, Treasury traders have been telling us that they substantially differ in their outlook with the BSP.
Remember, these people comprise mainly the trading desks of the domestic and foreign financial institutions, which include publicly owned or controlled financial institutions. As of June 2021, based on ADB data, the distribution of investor profile of local government currency bonds consists of banks and investment houses account for 37.9%, CSIs or Contractual Savings Institutions (Pension and Insurance) and Tax-Exempt Institutions 35.4%, BTR Managed Funds 8.6%, Brokers, Custodians and Depositories 9.6%, GoCCs and LGUs .01%, and Others 8.4%.
The mounting divergence between the BSP and treasury markets, thus, magnifies the risk of unintended consequences.
This policy gambit is likewise manifesting in different parts of the domestic Treasury markets. For instance, the 20-5 year spread has recently collapsed at the fastest rate since 2014 (at least). (Figure 1, second to the highest window)
There was a similar flattening episode in 2018. But compared then, the 20-year yields dropped faster than the 5-year. The 2018 episode signified a bullish flatter.
Current developments represent the opposite—the 5-year yield has sprinted faster than the 20-year or a bearish flattening. (Figure 1, window above the lowest pane)
A bearish flattener, notes the Investopedia, "refers to the convergence of interest rates along the yield curve as short term rates rise faster than long term rates and is seen as a harbinger of an economic contraction."
It is also a signal in anticipation of the central bank "embarking on a tightening policy," which is perceived as a "negative for the stock market."
The PSEi responded negatively to the 2018 occurrence.
In this instance, the Treasury markets seemingly indicate that the BSP has erred with its present stance and may be bound to do a catch-up. Or, it may hurriedly raise rates!
On the other hand, the widely used 10-2 year benchmark exhibits escalating expectations of inflation through a bearish steepening. (Figure 1, Lowest pane)
So, as a consequence of the present policies, the Treasury markets portend a stagflationary scenario, which contradicts the roseate expectations of the BSP.
III. Philippine-US Treasury Yield Differentials Exhibit Domestic Vulnerabilities
The attribution bias afflicts most of the mainstream experts. They tell the vulnerable public that economic and financial shortcomings emanate from external events while strengths are innate.
However, there is little connection with the likely policy path with the US Federal Reserve.
Or, don’t blame the US Federal Reserves for domestic events.
Figure 2
Philippine 10-year rates have risen way way way faster than its US contemporary. (Figure 2, upmost and middle pane) This premium embeds domestic inflation rather than exogenous influences.
From an investing perspective, please do note that when the Philippine rates rose faster than the USTs, the USD Php surged. The 2014-2018 episode exhibited this.
And we are seeing shades of this today. The fundamental nuance today is that the massive interventions by the BSP have subdued the increases of the USD. Yet, such intervention induces the accretion of imbalances.
For instance, foreign exchange losses contributed heavily to the 3Q and 9M earnings setback of JG Summit Holdings, which likely represents FX leveraging.
Thus, the BSP has used the record foreign exchange borrowings by the national government and other reserve assets, signified by FX swaps, repos, and other derivatives, to manage the domestic exchange rate. (Figure 2, lowest pane)
However, given the massive buildup of USD shorts, current conditions could likely signify a scenario characterized by the calm before the storm.
Ergo, activities in the treasury markets presage a vastly higher USD-Peso.
IV. BSP Subsidy: Suppressed Interest Rates Equals Reduced Bank Cost of Funds; The Evidence: PSE banks
If the economy is so healthy as popularly touted, why does the BSP continue to resist changes in its present policies?
The short answer is to continue bailing out the banking system through financial repression or redistributive policies.
First, low policy rates function as a subsidy to the banking system through suppressed deposit expenses.
Figure 3
Since peaking in the 1Q 2019, growth of bank interest expenses tumbled along with BSP rate cuts, which also commenced during the same period. The BSP’s rate cuts pulled the bank’s cost of funding lower thru the present.
The banking system reported a 39.65% decrease in interest expenses in the 3Q, a significantly lower from the 44.15% drop in the 2Q.
Meanwhile, PSE-listed banks reported interest expense deflation of 33.69% in the 3Q and 51.7% in the 9-months of 2021.
The slowing pace of decline of the banking system's interest rate expenses are signs of the diminishing returns of the BSP’s subsidy, reinforced by the rising yields.
Haven't we heard that because domestic banks are supposedly sound, it is recovering swiftly? Why then resist tightening?
But they are in a pickle, if the BSP raises rates, even by a margin, it would be like pulling the rug from under on the banking system!
From this angle, it seems clear why the BSP is gambling with the financial system through its current policy.
But there is no free lunch.
There are always unintended consequences from such redistributive policies. In essence, savers pay for rescuing the banking system, which firms are generally owned by the elites and some by the government. The reverse Robin Hood.
Despite the September 9.5% bounce, the growth rate of peso deposits remains on a downtrend.
In the meantime, deposit liabilities of listed banks, which include FX deposits, grew by 8.07% in the 3Q.
Deposit gains emanated likely from increased bank lending to the government and select borrowers (most probably PSE firms).
V. BSP Subsidy: Inflation Tax Benefits Borrowers (Government, Banks and Elites)
Figure 4
Next, such artificial low rates provide subsidies to borrowers at the expense of savers and creditors, called the inflation tax. The peso is also a victim of such implicit transfers.
Again, the government, the elite-owned banking system, and their clients (also elite-owned firms) account for the biggest borrowers in the economy. Many of these firms are listed on the PSE.
At present, the negative differentials or the spread between the subdued CPI and the BSP’s ON RRP policies are at record levels. (Figure 4, topmost pane)
The thing is, surging yields in the treasury markets indicate defiance to the BSP's policies, conveniently excused using the embellished CPI statistic.
Further, as mentioned above, rising yields have been eroding the implicit strip mining of savers from such BSP-induced redistribution.
Under the present conditions of unprecedented liquidity and relief measures, it is good news that the reported Bank Net NPLs appear to have tapered.
But higher rates led to a rise in Net NPLs even before the pandemic, which means today’s extended leverage from select sectors and firms will make them more vulnerable to rising yields! (Figure 4, middle pane)
It is a folly to believe that the BSP policies are intended for the long-term consequences when effecting transfers to the politically privileged group to forestall a debt crisis signifies its unpublished goals.
Watch what authorities do than what they say.
A similar precept should apply when reading the mainstream analysts.
It seems oxymoronic to know that treasury traders have been betting against them.
VI. Magic of the BSP’s Bailouts: Despite Twin Deficits on Core Operations, Bank Profits Boomed!
PSE-listed banks reported their Financial Statements last week.(Figure 3 lowest pane)
Despite the sharp drop in growth in Q3, 9-month net income rose by a phenomenal 47.5%.
Meanwhile, deflation in interest revenues slowed, down 8.15% in Q3, contributing to the 9-month revenue improvement to -13.45%.
Figure 5
Despite the widening margins from a steeping yield curve, 9-month net interest margins grew by 12.22%, lower than 20.34% in the same period last year. (Figure 5, topmost pane)
The average interest income margin was 83.15% in 2021 against 74% in 2020.
And despite the sharp reduction in deposit expenses, the sector suffered an 11.9% loss in interest earnings, representing a fifth straight quarter.
Interestingly, as bank operations shifted from lending to speculation, non-interest income likewise endured a 5.07% loss, the most deficit since Q3 2017. (Figure 5, second to the highest pane)
Apparently, falling prices/rising bond yields of fixed income securities offset increased exposure by banks on the capital markets.
Banks may be shifting such losses to their Held-to-Maturity (HTM) accounts. As predicted last October:
Aside from diminishing returns from BSP subsidies, rising bond yields translate to investment losses on their fixed income portfolio. We expect to see bank holdings of Held-to-Maturity (HTM) rise.
Revival of Bank Lending and Public Spending as Drivers of CPI Expansion? Systemic Leverage Explodes! November 1, 2021
HTM growth appears to have bottomed while growth rates of Available for Sale (AFS) and Held for Trading (HFT) continue to slide. (Figure 5, lowest window)
Yet, the twin losses were manifested by a 4.4% deficit in operating income, the largest since Q2 2014.
But the supreme irony is, the sector still reported a 35.05% profit growth in Q3! (Figure 5, second to the lowest window)
How about that? Core operations of banks, namely lending and investments, registered deficits but profits boomed!
How did this happen? Well, the sector reported lower loan loss provisions compared to last year!
That’s the kind of magic the BSP’s bailout seems to have ushered: Pure accounting profits!
Remember, the reporting parameters of financial conditions have been different from the pre-pandemic era. Current conditions include distortions from various bailout measures (liquidity, relief, etc.) that sanitize many impairments.
VII. BSP Bailouts Swells Bank and Financials Share of GDP! Corroding Liquidity, and Has the Financial Bubble Hit a Wall?
Figure 6
And don’t forget, as a primary beneficiary of the BSP’s rescue efforts, the sector continues to seize a larger share of the GDP!
So even when banks reported Q3 GDP growth of only 6.4%, their share of GDP was adrift near the record highs! (Figure 6, middle window)
Imagine bailouts and negative revenues generating growth!
At the day’s end, there are innate signs of corrosion of the liquidity conditions of the banking system.
The Banking system’s cash to deposits have begun to sink while liquid assets to deposits appear to have plateaued. And these are being manifested in the Treasury markets. (Figure 6, upmost pane)
More importantly, increasing reliance on bailout measures appears to be incentivizing banks to take on more risks than warranted. Such signifies the moral hazard in motion.
Paradoxically, in the thrust to attain the 7,400-level of the PSEi 30, repeated orchestrated attempts to push shares of the PSEi banks, the third wave of rotations, may have hit a wall. (Figure 6, lowest pane)
PSEi 30 7,200: The Financial Bubble Triggered, The Race Between the PSEi and Bond Yields October 18, 2021
It will be interesting to see the outcomes of such cumulative imbalances!
Yours in liberty,
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