If a million people say a foolish thing, it is still a foolish thing.—Anatole France [Jacques Anatole Thibault 1844-1924]
In this issue:
Liquidations in Philippine Assets Intensify: Treasuries, Peso, and Equities; From Elevated CPI to Bursting Bubbles
-The Window to Access Cheap Money Has been Shutting Everywhere
-Liquidations in the First Philippine Asset: Philippine Treasuries
-Liquidations in the Second Asset: The Philippine Peso
-Liquidations in the Third Asset: Philippine Equities
-The Panic Over the CPI as the Political Capital of the Leadership Erodes
-From Inflation to Bursting Bubbles
Liquidations in Philippine Assets Intensify: Treasuries, Peso, and Equities; From Elevated CPI to Bursting Bubbles
Last week, I pointed to the rising cost of external and internal funding.
[see The BSP in a Panic: Drastically Hikes Policy Rates and Slashes Deficit Financing To Curb Demand as M3 Growth Plunges!October 1, 2018]
The gist: the window to access cheap financing has been shutting everywhere.
The Window to Access Cheap Money Has been Shutting Everywhere
This week, US Treasury yields vaulted to multi-year highs across the curve. The yield of the benchmark 10-year spiked by 17 basis points (bps) to 3.23%, a May 2011 high, while the 30-year yield soared by 20 bps to 3.40%, its highest level since 2014
The 3 and 6 month Treasury bills, along with the 1, 2, 3 and 5-year notes and bonds spiraled to 2008 highs.
One month LIBOR rates, last quoted at 2.28%, reached 2009 levels.
The 10-year benchmarks of Japan and the UK reached the highs of January 2016 while Germany's 10-year bunds climbed to May 2018 levels. (Charlie Bilello of Pension Partners)
In the global bond market bloodbath, the biggest losses were endured by emerging market sovereigns.
To quote Doug Noland of the Credit Bubble Bulletin: “Ten-year (local) sovereign yields surged 33 bps in Indonesia, 26 bps in Russia, 21 bps in South Africa, and 14 bps in Hungary. Dollar-denominated EM debt provided no safe haven. Venezuela's 10-year dollar yields surged 70 bps to 38.55%; Argentina's 64 bps to 9.90%; and Turkey's 52 bps to 7.86%. Ten-year dollar yields jumped 19 bps in Indonesia, 19 bps in Chile, 18 bps in Russia, 17 bps in Mexico and 14 bps in Colombia.”
The Indonesian rupiah fell to a fresh Asian Crisis low this week. The peso dropped to close to a 12-year low.
Liquidations in the First Philippine Asset: Philippine Treasuries
Compared to the performance of the local currency treasury market, the selloff has been more intense in the Philippines.
Figure 1
And it’s not just the bills.
Yields of 1-, 2-, 3-, 5- and 7-year notes and bonds spiraled to 2009 levels! The 4-year yield closed at 2008 levels! Yields of the longer end 20-year reached 2011 highs, while the 25-year at 2010 highs!
In the context of prices, the equivalent of a yield spike is a price plunge!
Liquidations have been escalating in the domestic Treasury markets.
So not only will the banking system suffer from reduced credit volume (from higher rates), and diminished interest margins (from the flattening and the inverting curve), investments losses will compel a buildup in HTMs holdings that will further diminish liquidity in the system! NPLs should worsen too!
So do expect for banks to appeal to the public for more rounds of funding via LTNCDs, bonds, commercial papers, medium-term notes, retail bonds, stock rights and a combination thereof. [See The Crowding-Out: Wave of Announcements for Another Round of Massive Bank Financing! The Minsky Cycle to the Minsky Moment September 23]
And time is ticking for the industries that have thrived on credit for expansion and survival.
Recall the BSP-led Financial Stability Coordination Council’s (FSCC) 2017 Financial Stability Report where they raise the 3Rs?
…one has to also appreciate the higher debt levels against the potential risks from rising interest rates and the peso depreciation. This is a debt service burden issue and is at the core of what is referred to as the 3Rs or repricing, refinancing and repayment risks. (p.22)
A Black Swan-Minsky Moment or a financial-credit event gets magnified with an escalation of increases in rates!
And rising rates have not just been a function of inflation. It reflects on the crowding out effect from the government’s record fiscal deficit, as well as, the intensifying competition for access to savings by the banking system, the non-bank industries, consumers and the elephant in the room, the government. It also reveals the declining pool of savings. Eventually, it will incorporate credit risks in its pricing.
Also, given that the world’s monetary system has been anchored and operates on the US dollar, a sustained rise in UST yields will likely pull along with it the world’s fixed income markets.
Liquidations in the Second Asset: The Philippine Peso
Declining USD liquidity here and abroad will also influence local rates.
And this is one reason behind the tight correlation between the 10-year UST and the Philippine equivalent.
Rising US dollar rates means reduced access to the US dollar funding.
And not only does this extrapolate to higher debt servicing costs, but such would also magnify the exposure of US dollar liabilities which would serve as an effective drain to domestic USD liquidity.
Rising rates, thus, amplify the “US dollar shorts” of the Philippine financial system.
Again, the BSP led FSCC recognizes this predicament: “unless the borrowers are generating USD incomes sufficient to cover debt servicing, on balance, the higher overall debt puts pressure on USD liquidity in the country.” (p.26)
Figure 2
Rising rates translate to more costly funding for trade deficits, domestic dollar-denominated liabilities and the cost to maintain GIRs through loans, forex/currency swaps, and forward cover.
September’s Gross International Reserves fell 7.2% to register the biggest monthly (yoy) decline since August 2001. (figure 2, upper window)
The BSP defended by the peso directly and indirectly by providing the US dollar requirements to the financial system. UST holdings of the Philippine government have been rapidly shrinking based on the July data of the US Treasury Department. It must have dropped by more in September. (figure 2, middle window) Record forex holdings of the GIRs dropped by USD 910.65 million, aside from supporting the peso, the reduction may have reflected the rising costs of derivatives. (figure 2, lower window)
And in spite of the massive support, the USD peso still fell by 1.02% in September.
Where would the USD peso be without the BSP’s interventions?
So aside from bonds, the peso has likewise been enduring intense liquidations. Could this have been about capital flight too?
And because reserves are finite, there are limits to the BSP’s support of the peso.
Should the BSP and its banking agents borrow to fund its dollar requirements and to buoy the peso, they would be enlarging their exposure to the “US dollar shorts”. Short-term fixes would entail greater structural risks over time.
That said, aside from the political urgency to contain the CPI, the dramatic fall in reserves may have another reason for the BSP’s drastic tightening. By restricting domestic demand (credit expansion and money printing), it may conserve its inventory of USDs.
The USD Peso closed the week .39% higher to 54.23.
Liquidations in the Third Asset: Philippine Equities
Plunging bonds and falling peso has a third member account for two of the three financial assets being liquidated. The third is domestic equities.
Despite the massive pumps and occasional dumps, the PhiSYx plunged 2.73% to account for a fifth straight week of decline.
Pumps and dumps have accounted for a whopping 1.5% this week. At 7080, the average PER (2017 eps) remains at 17.87 while the market cap PER was still at 21.87. And the source of their earnings has been mainly from credit expansion.
I proposed buying the USD-Php as far back in 2014, just right after the BSP blew money supply growth by over 30% in 10 successive months. Despite what I see as a potential interim rally by the peso in response to the BSP’s tightening, this rallyshould be short-lived and serve as a springboard to the USD-Php which I believe should breakthrough to a fresh high.
Liquidations of the Philippine assets have benefited the USD-Php in 2018.
In 2017, the Phisix posted a stunning 25.11% return while the USD peso registered a measly .42% gain for a variance of 24.68% in favor of the national equity benchmark.
The table appears to have turned or fortunes have shifted.
As of Friday, the PhiSYx was down 17.3% year-to-date while the USD peso was up 8.61% for a 25.91% differential in favor of the USD peso with a quarter to go.
The momentum in favor of the USD-Php should accelerate as it approaches the October 13, 2004 record high at 56.45. The surfacing of unsustainable economic and financial imbalances should serve as the engine for its escalation.
The Panic Over the CPI as the Political Capital of the Leadership Erodes
All eyes have been on the CPI.
The Philippine Government reported September CPI (2012 base) at 6.7% which was above the Department of Finance’s forecast of 6.4% and a tad below the BSP’s projection of 6.8%.
The CPI calculated from the old 2006 would reflect about 7.3%. Arguing over statistics represents such fatuousness. The outcry hasn’t been about the CPI number, but about the decaying standards of living!
The DOF chief Carlos Dominguez admitted subtly that aside from supply, demand is being tackled with to arrest the CPI: "We are experiencing the headwinds but I think we are tackling them both from the monetary policy side as well as from the administrative side," Dominguez said.”
Interestingly, this media account has given the best explanation of the inflation picture: “The Bangko Sentral ng Pilipinas has so far raised its key interest rate by a total of 150 basis points, or 1.5 percentage points this year, in hopes of reining in inflation. The higher interest rates make borrowing money costly, thereby reducing the volume of money in circulation. Fewer pesos chasing goods has the effect of easing the pressure on inflation.”
In gist, inflation is about more pesos (demand) chasing fewer goods (supply). And the National Government has been moving heaven and earth to contain it, with little consideration of its consequences.
A Frankenstein created by them which they declare pretentiously to take down.
Why wouldn’t they? Popularity ratings of the leadership and his administration have gone down materially. Media, polls and street politics have ganged up on the CPI. So Red October, a controversial amnesty of the member of the opposition and theleadership’s health issues have surfaced to muddle or divert the public’s attention.
Again, social sensitivity to inflation is about standards of living and not statistics
Naturally, if econometric models have anchored their diagnostics, then the therapeutic prescriptions will also be sourced from it.
For instance, the effects of the “aggressive” 100 basis points increase in policy rates in August and in September plus the BSP’s pullback in financing the National Government’s expenditure in August has yet to appear in the economy and statistics. The BSP has gambled that this would have mild effects. (watch the banking system)
Nevertheless, with domestic liquidity continuing to recede, aside from its impact on prices (General Wholesale, Construction Retail, and Wholesale Material Prices), even the latest manufacturing growth survey have shown a material growth deceleration. (figure 3 lower window)
Importantly, September’s core CPI appears to have stalled which backs the BSP projection that statistical inflation may have “peaked”. The coming slowdown in CPI may be more about a reprieve than a “peak” (figure 3 upper window)
With lesser money chasing more goods, prices will indeed fall.
Aside from demand policies, the administration has embarked on short-term solutions such as mass importations of affected goods directed at resolving shortages to solve the supply issues.
Of course, the urgency to address the CPI would have unseen ramifications on other parts of the political economy. Some examples: fiscal deficits would increase; spending on imports diverts away spending on other political projects; though lowering tariffs should be a great move, the government prefers a centrally planned outcome from controlled markets, and many more
As such, to demonstrate the omniscience of the government, “Roque said Memorandum Order No. 26 “included the need for the government to have its own markets so that the role of traders will be gone here.” (Inquirer, September 26, 2018)
For a government to have its own markets translates to price controls. Incredible hubris.
But the coming drop in the CPI will be plagued by unintended consequences. A sharp reduction in demand will likely spur it.
And hardly anyone seems to recognize this.
The spate of economic growth mini downgrades from the IMF, ADB, Sunlife, World Bank, and AMRO has sorely missed the picture. These downgrades signify as an ex-post reaction to the 2Q GDP and focus solely on statistics while severely underestimating the impact of street inflation.
And it exhibits why crises occur, nobody sees them coming.
From Inflation to Bursting Bubbles
Unfortunately, people hardly learn from the lessons of history. We have seen this before.
For a system heavily dependent on easy money, withdrawing credit inflation translates to a massive withdrawal syndrome
Figure 4
Diminished bank credit growth should lead to lower GDP, a decline in earnings, reduced investments, diminished taxes, job losses and heightened challenges to credit conditions.
When the BSP tightened in 2014 in response to an escalation in inflation pressures, the CPI tumbled in response. Inflation spiraled when the BSP fomented a frenetic credit growth of 30%+++ in 10 successive months.
But this came about with the downshift in the real or headline GDP in 2015 (figure 4, upper window). The fall in bank lending reduced demand and had been instrumental in the GDP’s decline. (figure 4, middle window) Tax revenues also dived when bank credit growth fumbled (figure 4, lower window).
The former BSP Governor Amando Tetangco Jr. then repeatedly used oil prices to raise the specter of “disinflation” on manyoccasions in early 2015. At the end of that year, in response to “disinflation” which affected the banking system most, the BSP launched or activated its version of “quantitative easing”.
The 2014-2015 era signifies an ocean away from the current operating environment.
Back then it was all about the bubble economy. The present setting is about a bubble economy AND a bubble (neo-socialist) government.
The current environment has been undergirded by a combination of policy stimuli unmatched in history: record deficit spending, interest rates at record low and unprecedented debt monetization. Yes, the Philippine economy has survived on extended use of emergency fiscal and monetary measures
And the offshoot to these has led to socio-economic and political complications: an overhaul of the tax regime, reduction of liquidity in the banking system, the closure of Boracay, war on different industries, excess capacity in bubble sectors, under investments in agriculture, myriad social and commercial regulations and more.
Needless to say, the current environment IS fragile to policy miscalculations. The outbreak of street inflation represents an example of unforeseen outcomes from current and previous policies
In reality, because inflation is a cheap and invisible means of transfer or subsidies, the government desires it, as the great Ludwig von Mises wrote in his magnum opus Human Action,
The pretended solicitude for the nation’s welfare, for the public in general, and for the poor ignorant massesin particular was a mere blind. The governments wanted inflation and credit expansion, they wanted booms and easy money (p.441)
And the current waves of liquidations signify as initial manifestations to the unraveling of malinvestments.
When CPI falls enough to impair conditions of the banking system, the BSP will double down on its QE. Inflation will rage anew. Rising interest rates will pick up speed until something breaks. BOOM
As noted last week, the prospective pullback in demand that slows the CPI may lead to a temporary rally of the peso.
But many factors such as capital flight, dollar shorts, the funding of record deficits, external influences, and more importantly, domestic policy responses to the consequences of a lower CPI should send the USD Php stronger over time.
*US bonds, markets and economy, protectionism, China’s slowing debt-financed economy, Italy-Eurozone political imbroglio, escalating Middle East conflict, Emerging Market turmoil and etc
