Important Insights from the Philippine PSEi 30’s Melt-Up!

 

Investors believe in Keynesianism.  They believe that increased government spending will make us all richer.  This illusion is what is driving this stock market. Bubbles are based on illusions—Dr. Gary North 

In this issue

Important Insights from the Philippine PSEi 30’s Melt-Up!

I. Philippine PSEi 30 Returns Among the World’s Highest

II. Lessons from China’s Previous Easy Money Experiments

III. Market Concentration and Unimpressive Volume and Breadth, Rampaging Philippine Bank Shares and the Lehman-Bear Stearns Experience

IV. Retail Players Emerge

V. Why the Opposite Direction of San Miguel’s Share Prices? Conclusion

Important Insights from the Philippine PSEi 30’s Melt-Up!

What does the outperformance of the PSEi 30 likely mean?

I. Philippine PSEi 30 Returns Among the World’s Highest

The Philippines' primary equity benchmark, the PSEi 30, stretched its weekly winning streak to five with this week’s 0.53% gain.

This week’s gains pushed its year-to-date returns to 15.8% (as of October 4th).

Figure 1

Accompanied by a massive rally in the Philippine peso, the Philippines' ETF, the EPHE, joins the ranks of global top equity ETFs in terms of US dollar returns (as of October 2nd). (Figure 1, upper window)

Year to date, the PSEi 30 ranked fourth in Asia, after Pakistan, Hong Kong, and Taiwan. (Figure 1, lower image) 

With 16 of the 19 regional benchmarks up by an average of 13.13% in local currency terms, we can generalize that 2024 has been a year of the bulls. Of course, we have two more months to go.

II. Lessons from China’s Previous Easy Money Experiments

Despite recent elevated rates, the current surge in global stocks signifies a product of easy money.

Due to the massive coordinated bailout package unleashed by Chinese authorities to rescue its struggling asset markets (stocks and real estate), Chinese and Hong Kong equities skyrocketed, rising by a stunning 23.4% and 31% over the last four weeks.

However, the returns of China’s equity markets have been capped due to a week-long holiday.

Figure 2

Though many international experts have suddenly become apostates to a perceived return of China’s bull market, I recently pointed out in a tweet that... (Figure 2)

"While previous episodes of government stimulus did bolster valuations, they turned out to be short-lived, highly volatile, and resulted in diminishing returns for #SSE levels. The 2016 & 2020 support had little impact on its bear market. Will history rhyme?"

Or whatever boom that took place before tended to morph into a bust. Even worse, the subsequent stimulus produced diminishing returns with the lower levels of the Shanghai Composite Index (SSE).

In other words, monetary inflation or stimulus from credit expansion must be applied at a much larger scale than before to magnify the effects of a boom. 

As the great Dean of Austrian economics, Murray Rothbard, once warned 

Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance by repeated and accelerating doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop or sharply slow down, either because the banks are getting shaky or because the public is getting restive at the continuing inflation, that retribution finally catches up with the boom. (Rothbard, 2015)

China’s experience has somewhat resonated with the Philippines.

Figure 3

It took a combination of historic rate cuts, massive reductions in reserve requirements, unprecedented relief measures, and direct injections by the BSP into the banking system via the expansion of its balance sheet to rescue the Philippine PSEi 30 in 2020. (Figure 3, upper image) 

The PSEi 30 peaked in 2022 along with the cresting of the BSP's assets. 

It is also not a coincidence that the PSEi has wilted in the face of the slow-motion erosion of the BSP’s balance sheet, which was eventually reversed in 2023. 

The BSP’s U-turn put a floor under the PSEi 30 and rebooted the current rally. 

One can probably thank Other Financial Institutions (OFCs) for representing part of the National Team supporting the PSEi 30. 

The BSP has been rebuilding its asset base, this time from external borrowings by the National Government and the banking system. 

III. Market Concentration and Unimpressive Volume and Breadth, Rampaging Philippine Bank Shares and the Lehman-Bear Stearns Experience 

Of course, the difference between the bull market of 2009-2013 and today is that the PSEi 30 run has barely been supported by volume and breadth. 

Main board volume remains substantially below the level reached at even lower PSEi 30 levels in 2022. (Figure 3, lower graph) 

Because of this obsession with pumping the index to portray a bull market, the "national team" has concentrated its aggressive stock-pumping activities on the top heavyweights. 

As a result, the market capitalization share of the top five companies reached 51.1% last October 4, following a record 51.92% last April.

Figure 4

Furthermore, because RRR cuts and BSP rate cuts were sold to the public as policies that would accomplish economic nirvana, the Financial/Banking Index roared, with year-to-date returns spiking 37.7% and its index soaring to a record high! (Figure 4, upper chart) 

Astoundingly, shares of China Bank [PSE:CBC] have spiraled in ways echoing Bitcoin, GameStop [NYSE:GME], and Nvidia [Nasdaq:NVDA]! (Figure 4, lower pane)

CBC posted 91.3% year-to-date returns, with much of that accomplished in the last four weeks!

Figure 5

If history tells us anything, bank share prices going berserk could mean anything other than economic or financial prosperity. The experiences of Lehman Brothers and Bear Stearns provide examples: their share prices sprinted to an all-time high before collapsing, heralding the Great Financial Crisis (2007-2008). (Figure 5, topmost chart)

To be clear, we aren’t suggesting that CBC and other record-setting bank shares, such as BPI, are a simulacrum of Lehman; rather, we are pointing to the distortive behavior of speculative derbies that may hide impending problems in the sector. 

Of course, foreign buying did provide support to the national team. For the first time since 2019, the PSE posted net inflows of Php 108 million in the first nine months of 2024. (Figure 5, middle graph)

Meanwhile, in the PSE, the cumulative market share of the PSEi 30’s best-performing ICT and the three PSEi 30 banks has reached 32.73%, which is closing in on August's record of 33.14%.  

IV. Retail Players Emerge 

However, signs indicate that the retail segment appears to be jumping on board the developing mania, which has been marketed as another version of the "return of the bull market." 

Though still negative, 2024’s nine-month breadth has had the best showing since 2017. (Figure 5, lowest image)

Figure 6

Furthermore, the declining share of the top 10 brokers relative to the MBV could be another contributing factor. It was 60.4% in the week of October 4th, down from a recent high of over 65%. (Figure 6 upper visual) 

Major brokers could utilize 'done-through' trades or outsource trades with partner brokers to conceal or dilute this number.

Despite the paucity of volume, the trading share of the top 20 most-traded issues has dropped to about 80% for the fourth consecutive week from the previous range of 84-86%. (Figure 6, lower diagram)

Figure 7

Since the low on June 21st, the returns of the top 10 heavyweights delivered the bulk of the gains for the PSEi 30. While 23 issues closed higher, 2 remained unchanged, and 5 declined. The average return of the top 5 was 26.84%, while the average return for the top 10 was 26.4% (Figure 7, topmost graph) 

Breadth was largely incongruent with this week’s 0.53% returns, 83% of which were attributable to Friday’s pre-closing pump. Although 18 of the composite PSEi 30 issues closed down, the upside volatility allowed for a positive weekly return of 0.21% (Figure 7, middle image) 

V. Why the Opposite Direction of San Miguel’s Share Prices? Conclusion 

Finally, SMC share prices continue to move diametrically opposite to the sizzling hot PSEi 30. (Figure 7, lowest graph) 

What gives? Will SMC’s debt breach the Php 1.5 trillion barrier in Q3?   

Have SMC’s larger shareholders been pricing in developing liquidity concerns? If so, why are bank shares skyrocketing, when some of them are SMC’s biggest creditors? 

Bottom line: The levels reached by the PSEi 30 and its outsized returns attained over a few months barely support general market activities, which remain heavily concentrated on the actions of the national team and volatile foreign fund flows. 

Instead, the present melt-up represents an onrush of speculative fervor driven by the BSP’s stealth liquidity easing measures, even before their rate cut. Moreover, real economic activities hardly support this melt-up.

___

reference 

Murray N. Rothbard, Why the Recurring Economic Crises?, August 27, 2015, Mises.org

 

Marcos-Nomics Stimulus Update: August Budget Deficit Narrows, Strong Peso Reduces Public Debt, and Amortization Payments Reach All-Time High!

 

Lowering rates is a tool to rescue the government, but it will also make the Treasury add more debt in the next few months. If you make it easy for governments to borrow, they will gladly do it and continue printing currency, leading to the currency’s slow decline—Daniel Lacalle 

In this issue

Marcos-Nomics Stimulus Update: August Budget Deficit Narrows, Strong Peso Reduces Public Debt, and Amortization Payments Reach All-Time High!

I. A Growing Dependence on Non-Tax Revenue Growth? Or, Padding the Government’s Top line?

II. August’s Decline in Public Spending Due to Technicalities, Robust Pre-Election LGU Spending

III. Eight-Month Amortization Payments Hit All Time, Debt Servicing Cost at Annual 2023 Levels!

IV. Mounting Neo-Corporatism/Fascism Policies: Privatize Profits, Socialize Costs

V. Strong Peso Resulted in Lower Public Debt Last August

VI. Conclusion

Marcos-Nomics Stimulus Update: August Budget Deficit Narrows, Strong Peso Reduces Public Debt, and Amortization Payments Reach All-Time High! 

The "Marcos-nomics Stimulus" remains intact. Though deficit spending "narrowed" and public debt fell in August, technicalities and political agenda like pre-election spending points to the government’s deferred actions. 

GMA News, September 25, 1965: The Philippine government yielded a narrower fiscal shortfall in August amid growth in state collections and contraction in expenditures during the period. Data released by the Bureau of the Treasury on Wednesday showed the national government’s budget deficit stood at P54.2 billon last month, lower by 59.25% than the P133-billion fiscal gap seen in August 2023. “The lower deficit was brought about by the 24.40% growth in government receipts alongside a minimal 0.68% contraction in government expenditures,” the Treasury said. August’s fiscal balance brought the year-to-date budget shortfall to P697 billion, down 4.86% from the P732.5-billion deficit in the same period last year. 

Since the government has shifted VAT collections to an end-of-quarter basis, and given that the majority of public spending is typically programmed for the end of the quarter, the essence of the government’s balance sheet scorecard will be most relevant at the end of each quarterly period. 

In any case, we’ll do a short analysis. 

I. A Growing Dependence on Non-Tax Revenue Growth? Or, Padding the Government’s Top line?

Figure 1 

Although it is true that the fiscal deficit improved in August—largely due to a combination of decreased expenditures (-0.7% YoY and -9.4% MoM) amidst a mixed performance in revenues (+24.4% YoY and -15.5% MoM)—the most significant aspect is that the year-to-August deficit dropped from the third highest to the fourth highest in the Treasury's records. 

Nonetheless, nominal figures suggest that August's performance aligns with the exponential trendline for both variables. Additionally, the general uptrends in revenues and spending remain intact. (Figure 1, topmost pane) 

As such, since peaking in 2020, 8-month financing by the Bureau of Treasury has slowed compared to last year. The Treasury remains liquid, with approximately Php 504 billion in cash, marginally lower than Php 509 billion last year. (Figure 1, second to the highest chart) 

But the thing is, non-tax revenues have anchored a substantial segment of the progress in revenue collections. Non-tax revenues rocketed 252% year-over-year last August and soared 58.9% year-to-date compared to the same period in 2023. This growth spike pushed up the segment’s share of revenue to 17.12%—its sixth consecutive month of double-digit representation. In the eight months of 2024, the non-tax revenue pie swelled to 14.53%—the highest since 2015 (Figure 1, second to the lowest and lowest graphs) 

According to the Bureau of Treasury: Income collected and generated by the Bureau of the Treasury (BTr) rose to P16.5 billion in August, more than twice its collections in the same period a year ago. The increase was primarily driven by PSALM’s P10.0 billion settlement of guarantee fee arrears, alongside increased PAGCOR income. Compared with January-August 2023’s actual collections of P150.1 billion, BTr’s YTD income for the current year has similarly improved by 33.46% (P50.2 billion) to P200.3 billion, largely due to higher dividend remittances, interest on advances from GOCCs, guarantee fee collections, and the NG share from PAGCOR income. Collections of other offices (other non-tax, including privatization proceeds, fees and charges, and grants) in August surged to P49.6 billion, nearly quadrupling last year’s outturn. (BTR, September 2024) [bold mine] 

Has the government been padding their revenue numbers partly by inflating the non-tax revenue component? Or are they becoming dependent on it? Unlike previous episodes where non-tax revenues spiked in a month or two, this marks the first time the share of this segment has been in double digits for six consecutive months 

II. August’s Decline in Public Spending Due to Technicalities, Robust Pre-Election LGU Spending 

The next item is expenditure.

Figure 2

Although decreases of .68% year-over-year (YoY) and 9.4% month-over-month (MoM) and year-over-year (YoY) were recorded in August, the expenditure for the first eight months grew by 11% YoY to a record Php 3.69 trillion. (Figure 2, topmost window)

The decline in August was primarily due to a -3.7% YoY and -4.1% MoM contraction in the National Government’s disbursement, even though spending by local government units (LGUs) remained vigorous at +9.34% YoY and -4.3% MoM.

But authorities explained the reasons behind this.

Again from the BTR: This can be partly attributed to the lower total subsidy releases to government corporations, and the sizeable outstanding checks recorded in various departments, such as the Department of Public Works and Highways (DPWH), the Department of Social Welfare and Development (DSWD), and the Department of Health (DOH), during the period. Outstanding checks represent payments made by line departments for the delivery of goods/services but are not yet presented for encashment at the banks by the concerned contractors or payees. These remain under the accounts of spending agencies in authorized government depository banks and are not yet considered as actual disbursements in the Cash Operations Report. [bold mine]

In short, the most recent uncashed disbursements from the National Government will be reflected in upcoming data.

As it stands, the brisk growth of spending by local government units (LGUs) likely signifies the pre-election (mid-term) spending.  The cumulative data for the first eight months (+9.65% YoY) reached its second highest level since the record set in 2022, which, coincidentally, was the year of the Presidential Elections. (Figure 2, lower window)

This trend is expected to be sustained as we approach the 2025 elections.

III. Eight-Month Amortization Payments Hit All Time, Debt Servicing Cost at Annual 2023 Levels!

Lower interest payments accounted for yet another reason behind the decrease in expenditures last August.

Interest payments fell by 33.6% month-over-month (MoM) but surged by 23.7% year-over-year (YoY).

Despite this, the cumulative interest outlays for the first eight months increased by 31.1% YoY, reaching an all-time high of Php 509.44 billion. Its share of allotment rose from 11.72% in 2023 to 13.81% in August, representing the highest level since 2009! (Figure 2, lowest chart)

That’s not all.

Figure 3

In peso terms, the amortization expenditures from January to August surpassed last year’s high, setting a new record! (Figure 3, topmost image) 

Strikingly, amortization expenditures for 2024 amounted to Php 1.041 trillion, which is 6.7% above the 2023 annual total of Php 975.3 billion.

While interest and amortization levels (in peso terms) reached milestone highs, the cumulative debt servicing costs for the first eight months amounted to Php 1.55 trillion—just 0.33% (Php 53.432 billion) lower than last year’s annual debt servicing cost of Php 1.604 trillion! (Figure 3, middle diagram)

Despite this data being publicly available, there has been little coverage by the mainstream media or commentary from the establishment.

More than anything else, do you see the reason driving the Bangko Sentral ng Pilipinas (BSP) to cut interest rates and reserve requirements (RRR)?

It’s all about an implicit government bailout through the provision of liquidity support and the lowering of debt servicing costs!

Net claims on the central government (NCoCG) by universal-commercial banks have risen in tandem with public debt. (Figure 3, lowest image)

Figure 4

These measures are part of the 2020 pandemic rescue template, which includes various regulatory accommodations (such as relief measures and subsidies) as well as direct interventions (liquidity injections) from the Bangko Sentral ng Pilipinas (BSP).

Even now, the BSP’s net claims on the central government (NCoCG) have mirrored the monthly oscillations in public spending. (Figure 4, upper visual)

Furthermore, considering the political economy's structure derived from trickle-down policies, these rescue efforts are not only designed to benefit the government; they also serve the interests of politically connected elites.

Fundamentally, the BSP provides elite-owned banks with benefits through favorable policies and implicit bailouts. In return, these primary financial institutions partially complying with capital requirement rules provide liquidity to the Philippine treasury markets.

Has the narrowed deficit been engineered to address this? We argue that it has not.

IV. Mounting Neo-Corporatism/Fascism Policies: Privatize Profits, Socialize Costs

Haven’t you noticed that this administration has been gradually appointing members of the elite circle to higher echelons of political power?

While the intention may be to create a "business-friendly" environment, this situation reeks of "pro-big business" rent-seeking cronyism.

How will MSMEs thrive in the face of the onslaught of inflation, taxes, and regulations being imposed?

For instance, due to mandates and new taxes, major online eCommerce platforms have required SME sellers to register with the government, comply with new regulations, and pay new taxes.

In response, an influx of aspiring online entrepreneurs has led to a significant surge in business registrations, which both the media and the government are celebrating as a boom!

But how many of these businesses will survive the sustained rise in inflation and the increase in compliance and transaction costs?

How many of these hopeful entrepreneurs—whether driven by necessity due to a lack of jobs or insufficient income—will be able to employ people, especially with recent increases in minimum wages?

Yet, who benefits from the reduction of competition? SMEs or the elites?

We read that some elites have partnered with the government to embark on initiatives to promote MSMEs.

While partnerships like these may seem ideal, how do raising barriers to entry actually promote entrepreneurship?

These initiatives, which the public perceives as beneficial political "do something" actions, are, in fact, a display (smack) of hypocrisy largely intended for election-related public relations.

Moreover, some proponents have advocated for the privatization of certain infrastructure institutions.

While this may seem beneficial in "simple" theory, without competition, tax relief, and the easing of regulatory and administrative obstacles, such privatization is likely to result in the privatization of costs while socializing losses, or could deepen the embrace of neo-fascism, corporatism, or crony capitalism.

V. Strong Peso Resulted in Lower Public Debt Last August 

Apart from inflation, the surge in debt servicing costs represents a secondary symptom of deficit spending, with the direct effect manifested through public debt.

From the Bureau of Treasury (BTR): National Government’s (NG) total outstanding debt stood at P15.55 trillion as of the end of August 2024, reflecting a 0.9% or P139.79 billion decrease from the end July 2024 level…Meanwhile, NG external debt amounted to P4.76 trillion, a decrease of 3.6% or P178.25 billion compared with the end of July 2024 level. The decline was brought about mainly by peso appreciation, which trimmed P194.90 billion, as well as net repayments of P4.17 billion, although stronger third-currencies added P20.82 billion in valuation effects (BTR, October 2024) [bold added]

As the BTR admitted, the revaluation effects stemming from a rare 3.9% appreciation spike in the Philippine peso, based on their data, contributed to a marginal reduction in Philippine debt. 

Breaking down the data: external debt decreased by 3.6% month-over-month (MoM) but rose by 4.4% year-over-year (YoY). Meanwhile, domestic debt increased by 0.4% MoM and 10.22% YoY. (Figure 4, middle image) 

As a result, the spike in the Philippine peso pulled down the percentage share of external debt relative to the total, which has been rising since its trough in March 2021. 

Although the narrowing of the budget deficit from July to August, driven by a slowdown in public spending, may alleviate some pressure to increase borrowings, it is likely that the government has merely deferred its spending pressures to the end of the quarter and the end of the year.  (Figure 4, lowest image) 

Second, the government announced that it raised USD 2.5 billion last August. 

Figure 5

This addition will contribute to the external debt stock, which reached an all-time high in Q2 2024 and is expected to increase further in Q3. (Figure 5, topmost graph)

External debt has now surpassed the Gross International Reserves (GIR), even though part of these borrowings is counted as part of the GIR. For instance, when the National Government raised USD 2 billion last May, the proceeds were incorporated into the June GIR: "The month-on-month increase in the GIR level reflected mainly the National Government’s (NG) net foreign currency deposits with the Bangko Sentral ng Pilipinas (BSP), which include proceeds from its issuance of ROP Global Bonds." (bold added) (Figure 5, second to the highest chart) 

Make no mistake: borrowed reserves require payment, and treating them as retained earnings or savings misrepresents actual reserves. 

Third, it is doubtful that the recent appreciation of the Philippine peso is sustainable. 

In contrast, the rising trend of the USD-Peso exchange rate partly reflects the "twin deficits" as a consequence of the government’s deep embrace of Keynesian policies that posit spending will lead to economic prosperity. (Figure 5, second to the lowest and lowest graph) 

These deficit spending policies, which depend on an easy money regime favoring the elite, have led to a record savings-investment gap that must be funded by a domestic population constrained by low savings, making it increasingly reliant on overseas savings. 

In summary, the widening savings-investment gap—partially expressed through the BSP-Banking system's funding of historic deficit spending via record-high public debt—has contributed to the weakness of the Philippine peso.

Therefore, the current decline in public debt due to the peso appreciation represents an anomaly (a bug, not a feature) rather than a trend. 

With this context in mind, one must ask: who will bear the rising costs of ever-increasing public debt and its servicing—through higher taxes and inflation? 

Is it the elites, with their army of accountants and tax lawyers, shielding themselves from their direct obligations? Is it the elites who employ financial experts and, indirectly, the government, which allocates resources to benefit from inflationary policies? 

Or is it the average Mario and Juan, who have little means for protection? 

VI. Conclusion

The "Marcos-nomics stimulus" measures remain intact.

The recent cut in the official interest rate, along with an expected series of further cuts and adjustments to reserve requirements, indicates a sustained trend of deficit spending, point to an expansion of monetary easing aimed at jolting the private sector economy and achieving political agendas through spending on pre-election, the war economy, infrastructure, welfare, bureaucratic expansion and etc., in addition to boosting GDP for financing purposes.

____

References 

Bureau of Treasury, August 2024 NG Budget Deficit Down to P54.2 Billion, treasury.gov.ph, September 25,2024

 

Bureau of Treasury, National Government Debt Recorded at P15.55 Trillion as of End-August 2024, treasury.gov.ph, October 1, 2024

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion!

 

The short end of the UST curve is highly influenced by the Federal Reserve’s monetary policies while the long end clarifies those policies through the prism of risk/return. A steep yield curve…is one that suggests a low rate, accommodative monetary policy that is likely to work over time. This accounts for the curve’s steepness. A flat and inverted curve is the opposite. Whatever monetary policy is being conducted, the long end is interpreting that policy as well as other conditions as being highly suspect—Jeffrey P Snider 

In this issue:

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion!

I. 2024 Reserve Requirement Ratio Cuts to Designed to Plug the Banking System’s Worsening Illiquidity

II. Bank Liquidity Drain from Held to Maturity (HTM) and Growing Non-Performing Loans (NPL)

III. Philippine Yield Curve Shifts from an Inverted Belly to a Full Inversion!

IV. Was San Miguel’s September 20th Pre-Closing Dump Related to the Liquidity Strained Yield-Curve Inversion? 

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion! 

The Philippine yield curve inverts as the BSP significantly reduces the Bank RRR, while the US Fed embarks on a "Not in Crisis" 50-bps rate cut. 

The BSP has been telegraphing cuts to the banking system’s Reserve Requirement Ratio (RRR) since its last reduction in June 2023. 

For instance, Philstar.com, May 18, 2024: The Bangko Sentral ng Pilipinas (BSP) is looking at a significant reduction in the level of deposits banks are required to keep with the central bank after it starts cutting interest rates this year, its top official said. BSP Governor Eli Remolona Jr. said the Monetary Board is planning to cut the reserve requirement ratio (RRR) of universal and commercial banks by 450 basis points to five percent from the existing 9.5 percent, the highest in the region. 

Four months later. 

GMANews.com, September 18, 2024: The Bangko Sentral ng Pilipinas (BSP) is looking to cut the reserve requirement ratio, the amount of cash a bank must hold in its reserves against deposits, “substantially” this year and reduce it further in 2025. BSP Governor Eli Remolona Jr. said on Wednesday that the cut in the reserve requirement is being considered, with the timing being discussed. He earlier said this can be reduced to 5% from the present 9.5% for big banks. 

Two days after. 

ABSCBNNews.com, September 20, 2024: The Bangko Sentral ng Pilipinas is reducing the reserve requirement ratio (RRR) for universal and commercial banks by 250 basis points (bps).  This RRR reduction will also apply to non-bank financial institutions with quasi-banking functions, the BSP said… The reduction shall bring the RRRs of universal and commercial banks to 7 percent; digital banks to 4 percent; thrift banks to 1 percent; and rural and cooperative banks to zero percent, the central bank said. The new ratios take effect on October 25 and shall apply to the local currency deposits and deposit substitute liabilities of banks and NBQBs. (bold mine) 

I. 2024 Reserve Requirement Ratio Cuts to Designed to Plug the Banking System’s Worsening Illiquidity 

Bank lending growth has been accelerating, while broad economic liquidity measures have been rising, so why would the BSP opt to inject more liquidity through Reserve Requirement Ratio (RRR) cuts? 

The following data set may provide some answers.

Figure 1

Although lending by Universal and Commercial Banks is at a record high in nominal peso terms, the growth rate remains far below pre-pandemic levels. (Figure 1, topmost image) 

The RRR cuts from 2018 to 2020 appeared to have worked, as the loans-to-deposit ratio rose to an all-time high in February 2020 but the pandemic-induced recession eroded these gains. (Figure 1, middle graph) 

It took a combination of historic BSP policies—record rate cuts, an unprecedented Php 2.3 trillion liquidity injection, and extraordinary relief measures—to reignite the loans-to-deposits ratio. Nonetheless, it still falls short of the 2020 highs. 

A likely, though unpublished, explanation is that bank liquidity continues to decline. 

As of July, the cash and due-to-bank deposits ratio was at its lowest level since at least 2013. The BSP policies of 2020 and subsequent RRR cuts bumped up this ratio from 2020-21, but it resumed its downtrend, which has recently worsened. (Figure 1, lowest chart)

Figure 2

After a brief recovery from the RRR cuts of 2018-2020—further aided by the BSP’s historic rescue measures in 2020—the liquid assets-to-deposits ratio has started to deteriorate again. (Figure 2, topmost pane) 

Additionally, Q2 2024 total bank profit growth has receded to its second-lowest level since Q2 2021. (Figure 2, middle diagram) 

From this perspective, liquidity boost from increased bank lending, RRR cuts, and reported profit growth has been inadequate to stem the cascading trend of cash and liquid assets. 

Furthermore, despite subsidies, relief measures, and a slowing CPI, Non-Performing Loans (NPLs) and distressed assets appear to have bottomed out in the current cycle. (Figure 3, lowest visual) 

Increasing NPLs in the face of a slowing CPI is indicative of demand. Refinancing has taken a greater role in the latest bank credit expansion. 

To wit, rising NPLs contribute significantly to the ongoing drain on the banking system’s liquidity. 

II. Bank Liquidity Drain from Held to Maturity (HTM) and Growing Non-Performing Loans (NPL)

Figure 3

A primary source of the downtrend in the cash-to-deposits ratio has been the banking system's Held-to-Maturity (HTM) securities. (Figure 3 upper image)

Once again, the BSP has acknowledged this. 

Banks face marked-to-market (MtM) losses from rising interest rates. Higher market rates affect trading since existing holders of tradable securities are taking MtM losses as a result. While some banks have resorted to reclassifying their available-for-sale (AFS) securities into held-to-maturity (HTM), some PHP845.8 billion in AFS (as of end-March 2018) are still subject to MtM losses. Furthermore, the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity. [BSP, 2018] (bold mine) 

Even though rates have dropped, HTM (Held-to-Maturity) assets remain at record levels but appear to be plateauing. Falling rates in 2019-2020 barely made a dent in the elevated HTM levels at the time. 

Yet, a principal source of HTMs continues to be the bank's net claims on central government (NCoCG). (Figure 3, lower graph) 

That is, banks continue to finance a substantial portion of the government's deficit spending, which has represented an elementary and major contributor to the deterioration in bank liquidity. 

Why has the BSP been doing the same thing over and over again, expecting different results? Some call this "insanity." 

If the goal is to remove distortions—however ambiguously defined—why not eliminate the RRR entirely? 

It seems the BSP is merely buying time, hoping for a magical transformation of unproductive loans into productive lending. Besides, a complete phase-out of the RRR would leave the BSP with fewer "tools," or bluntly speaking, strip them of excuses. 

Thus, they’d rather have banks continue to accumulate unproductive loans in their portfolios and gradually subsidize them with relief from RRR cuts, rate cuts, various subsidies, and later direct injections—a palliative/band-aid treatment. 

III. Philippine Yield Curve Shifts from an Inverted Belly to a Full Inversion! 

Figure 4

Rather than steepening, the Fed's "not in a crisis" panic 50-basis-point cut also helped push the Philippine Treasury yield curve from an "inverted belly" to a "full inversion" on September 20! (Figure 4, tweet)

Figure 5

While yields across the entire curve plunged over the week, T-bill yields declined by a lesser degree relative to medium- and long-term Treasuries. (Figure 5, topmost window)

As a result, yields on Philippine notes and bonds have now fallen below T-bills!

Although one day doesn’t make a trend, this current inversion is the culmination of a process that began with a steep slope, then an inverted belly, and now a full inversion since June 2024. (Figure 5, middle chart)

The spreads between the 10-year bonds and their short-term counterparts are at the lowest level since March 2019! (Figure 5, lowest graph) 

And an inverted curve could serve as a warning signal/alarm bell for the economy.

From Investopedia: 

>An inverted yield curve forms when short-term debt instruments have higher yields than long-term instruments of the same credit risk profile.

>The inverted curve reflects bond investors’ expectations for a decline in longer-term interest rates, a view typically associated with recessions.

Further, it is a sign of tight liquidity: short-term borrowing costs rise or remain elevated, leading to higher yields on short-term debt instruments compared to long-term yields.

Moreover, expectations of slowing growth or economic recessions can also lead to decreased demand for riskier assets and increased demand for safer long-term bonds.

Again, the inverted curve must have resulted from the BSP’s announcement of a sharp reduction in the RRR in October, along with the Fed’s 50-basis point rate cuts.

Bottom line: cuts in the banks’ RRR were meant to address the banking system’s liquidity challenges as manifested in the Philippine treasury markets. The Fed’s 50-bps rate cut has exacerbated these distortions.

IV. Was San Miguel’s September 20th Pre-Closing Dump Related to the Liquidity Strained Yield-Curve Inversion?

Figure 6

Finally, it is interesting to observe that following the PSEi 30's intraday push above 7,300 last Friday, September 20, foreigners sold off or "dumped" SMC’s shares by 5% during the pre-closing five-minute float, contributing to the sharp decline in SMC’s share price and diminishing gains for the PSEi 30. (Figure 6, tweet) 

While we can’t directly attribute this to the inversion of the Philippine term structure of interest rates (yield curve), SMC’s intensifying liquidity challenges—evidenced by deteriorating cash reserves relative to soaring short-term debt in Q2 2024—should eventually influence its slope. (Figure 6, lower chart) 

In sum, as a "too big to fail" institution, SMC’s difficulties will inevitably reflect on the government’s fiscal and monetary health as well as the banks and the economy. 

____

references

FINANCIAL STABILITY COORDINATION COUNCIL, 2017 FINANCIAL STABILITY REPORT, p. 24 June 2018, bsp.gov.ph

US Federal Reserve Powell’s 50 bps Rate Cut: A Case of Panic or Politics?

  

"Theorie des Geldes" did not become the playbook for policy makers. The 1920s were marked by the brave new era of the Federal Reserve system promoting inflationary credit expansion and with it permanent prosperity. The nerve of this Doubting-Thomas, perma-bear, crazy Kraut! Sadly, poor Ludwig was very nearly alone in warning of the collapse to come from this credit expansion. In mid-1929, he stubbornly turned down a lucrative job offer from the Viennese bank Kreditanstalt, much to the annoyance of his fiancée, proclaiming "A great crash is coming, and I don't want my name in any way connected with it."—Mark Spitznagel

US Federal Reserve Powell’s 50 bps Rate Cut: A Case of Panic or Politics?

Was Federal Reserve’s Jerome Powell’s 50-basis-point rate cut a data-driven economic response, or was it aimed at tilting the presidential election odds in favor of the Democrats?

The U.S. Federal Reserve began its rate-cutting cycle with a surprise 50-basis-point reduction on September 18, 2024.

Figure 1

Historically, or based on the Fed's interest rate cycle, economic recessions or financial panics have often followed the Fed's interest rate cuts, a pattern that has been consistent since the 1970s.

In the present episode, as US stocks have been rocketing to establish back-to-back milestone highs. However, this supposedly presage a "long-term bull market," rather than a temporary spike—anchored on the popular rationale for a forthcoming economic slowdown that would signify a "soft landing."

The spillover effects of the easy money regime have not been limited to the US but global in scale.

Figure 2

US officials could be sugarcoating the current economic conditions. From a labor perspective, unemployment rates inevitably rise after the rate-cutting cycle begins. (Figure 2, upper window)

According to Mises Institute's chief editor Ryan McMaken: 

if one looks closely, one will not find a case of the FOMC slashing the target interest rate by 50 basis points when the economy “is in great shape.” On the contrary, a 50 bps (or larger) cut to the target rate tends to come just a few months before recession and a rising unemployment rate. If one looks only at the unemployment rate in these cases, one could see how the economy might look decent even when the Fed starts a rate-cutting cycle. Over the last thirty years, 50-basis-point panic cuts come when the unemployment rate is barely up from recent lows. 

Uncannily, the last time the Fed initiated a series of rate cuts with a 50-basis point reduction was on September 18, 2007. 

Like today, as pointed out in a thread on x.com by analyst Sven Henrich, US stock markets raced to their all-time highs while the notion of a soft landing permeated the landscape. (Figure 2, lower tweet) 

However, a recession began in December 2007, just three months later. 

This recession was not officially recognized until well into 2008, even as the Fed denied it in February of that year.

Figure 3

The S&P 500 $SPX soared by 6% in about a month to reach a new zenith. Yet, one and a half years later, the SPX plummeted by 57%, hitting its trough in March 2009. (Figure 3, upper chart)

As a side note, mirroring trends in the U.S., the Philippine PSEi 30 rocketed by 17% in less than a month to an all-time high of 3,873.5 on October 8, 2007, before crashing by 56% just over a year later.

On the other hand, the Fed has opened the 2024 cycle with a "panic" 50-basis point rate cut even when financial conditions have been the easiest since at least September 2023, according to Goldman Sachs calculations. (Figure 3, lower graph)

This means the Fed has opened the liquidity spigot even while U.S. (and global) stocks are experiencing a record-breaking winning streak accompanied by unprecedented levels of debt!

The transmission mechanism has been expressed in different economic spheres.

Figure 4 

As Bank of America’s Savita Subramanian observed, “We believe the key difference between this easing cycle and past cycles is the profits trajectory. Historically, profits have almost always been decelerating as the Fed first cuts rates, but that’s not the case today” (Figure 4, upper chart)

Of course, loose monetary conditions tend to spill over not just into share prices but also through various economic channels, partly via profit expansion (wealth effect).

Furthermore, as Credit Bubble Bulletin’s analyst Doug Noland noted, Unrelenting growth in government debt, intermediated through “repos,” the money market fund complex, the Securities Broker/Dealers, and the Rest of World (ROW). Unprecedented speculative leverage that creates both demand for securities and liquidity for asset inflation and history’s greatest Bubble. A historic Bubble in government debt issuance that has fueled asset Bubbles and resulting massive inflation in perceived household wealth, along with ongoing elevated incomes and spending. (bold mine)

So why would the Fed cut rates when current monetary conditions are easy?

U.S. presidential contender Donald Trump believes that Powell’s rate cut was a "political move."

Last June, Mr. Trump stated that he would not reappoint Jerome Powell.

Putting pressure, days before the interest rate decision, three Democratic leaders urged the Fed to implement a 75-basis point decrease.

By boosting the markets and delaying an economic slowdown, this move could increase the odds of a Democratic victory for President Biden's anointed Kamala Harris.

Has Powell thrown his lot with the Harris-Walz ticket to secure his reappointment?

For a non-partisan observer, will Powell’s panic cut result in a "this time is different" "soft landing?"

Or, is it merely delaying an inevitable economic reckoning? 

In the end, the USD price of gold sprinted to an all-time high. (Figure 4, lowest tweet)

Is this milestone driven by a mounting #FOMO among emerging market central banks? Is it a safe-haven response to the escalating Israel-Palestine war, Israel-Hezbollah war, or a broader war theater in the Middle East? Is it also factoring in global central banks trapped in their easy money policies, which have accelerated speculative mania and intensified systemic leverage?

We are living in interesting times.