Philippine Treasury Markets Exhibits More Symptoms of “Dislocations of Crisis Proportions”
It pays to emphasize this conclusion from the BSP-led Financial Stability Coordinating Council (FSCC)’s Financial Stability Report(FSR) 2017:
While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise. What is not debatable is that repricing, refinancing and repayment risks (3Rs) are escalated versus last year and this could result in systemic risk if not properly addressed in a timely manner
Since the BSP has been enlisted as a Bank for International Settlement (BIS) reporting country, the annual Financial Stability Report becomes part of its requirement. That said, though the primary audience for the FSR seems to be central bankers, it has been made available to the public.
Fundamentally, the National Government produces reports that cater to different audiences.
When in front of the BIS, they talk “Black Swans” and Minsky’s “Financial Instability Hypothesis”. When in front of domestic audiences, it is all about La La Land!
The risks it writes about in the FSR virtually vanished on its 1H report on the Financial System. Both reports cover almost the same timeframe but published with a 2-month differential, the FSR on August and the Financial System on October.
And here’s the thing.
The in-your-face rally in the stock market, led by the top 6 issues which now account for whopping 51.30% of the market capitalization of PSYEi 30, the second highest ever, attempts to show a hunky dory scenario of the financial system!
But that scenario has hardly been supported elsewhere.
The ferocity in the rally of the four banking majors has barely resonated with the performance of the broader banking system. [See Charts: Why the Janus-Faced Banking Stocks? PSEi Banks Versus The Rest November 26, 2018].
Not limited to the banks, such divergent performance has been evident even against the broader universe of listed issues. But this won't be tackled here.
More importantly, the “managed” treasury market seemingly opposes or rejects this roseate scenario.
In other words, the current trends in the Philippine Treasury’s yield curve herald MORE and not less problem ahead.
Let us dive into them.
Figure 1
PDS data provided by investing.com have been used above because the new BVAL metric lacks breadth in data.
The plunge in the yields of the bonds (10-, 20-, and 25-year maturities) highlights the market’s perception of a material slowdown in inflation. (figure 1)
In contrast, while the 3-month bills retraced slightly, generally the short-end of the curve continues to rise. The short-end continues to exhibit strains in monetary liquidity.
The divergence of yield actions has brought about a stunning narrowing or flattening of the yield curve!
Remember rising yields of T-bills have been an ongoing trend since 2016 that has only accelerated in the 2H of 2018. (figure 1 lower window)
Figure 2
The 10-year 6-month spread closed to its lowest level since late 2015 and 2016. The 10-year 1-year spread has narrowed past the 2015 lows! (figure 2)
Figure 3
ADB’s favorite benchmark, the 10-year 2-year spread, has dropped to 2015-16 lows. The spread with the belly (mid-curve) bounced from negative but has dropped to near to zero this week.
As repeatedly been stated here, the narrowing curve will hurt bank margins and profits. And inversions have typically been signs of either economic slowdown or recession.
So despite the BSP’s “yield management”, the treasury curve continues to reveal unpleasant developments within the financial industry.
If credit is the blood of the Philippine economy, the banking system is its heart
Figure 4
From the BSP: “Preliminary data show that domestic liquidity (M3) grew by 8.2 percent year-on-year to about ₱11.1 trillion in October 2018. This was slower than the 9.8-percent (revised) expansion in the previous month. On a month-on-monthseasonally-adjusted basis, M3 decreased by 0.1 percent.”
On a month on month basis, M3 dropped by a staggering 153 bps, that’s huge!
The October M3 rate of 8.23% hit a January and February 2015 low of 7.82% and 8.63%. (figure 3, lowest window)
Former BSP chief Amando Tetangco Jr. ranted about “deflation” or “disinflation” risks in his speeches during these days.
Having been stripped of transfers from the inflation tax, such had been the prime reason the BSP chief griped about positive real rates. (figure 4 topmost chart)
An even more important and related reason: with a system heavily dependent on credit, a meaningful slowdown in credit expansion would not only lead to an economic downturn but would also reinforce fragility embedded into the system.
Positive real rates had been the outcome of the M3 plunge in 2014-2015 of which penalized the banking system with initial losses and a slow recovery. (figure 4, middle chart) The banking system has never recovered its profit rate from 2009 to 2013.
It was because of such losses in the banking system that prompted the BSP to launch its version of Quantitative Easing in 2015.
Back then, crashing M3 was still accompanied by INCREASING peso deposit growth and cash and due banks in the banking system. Though money supply shrank, banking liquidity hasn’t been as much a concern.
And the current environment has been peeled off such cushions. (figure 4, lower chart)
The surge in 1-year yield has narrowed its gap with the CPI to only 40 bps at the end of the October. The interest subsidy favoring the NG has gone thin. The diminishing subsidy tells us that the BSP will soon stop tightening. (BUY the USD-Php!)
And if the CPI falls below the 1-year yield, then statistically speaking, we would have moved on or segued to a positive real rates regime. And neither the banking system nor the economy would thrive without facing significant risks and volatility under such environment.
There had been a lot less debt and more liquidity in 2015 than in the present. Yet, the BSP had to bail the system out with a QE in 2015 and the lowest interest rate in June 2016 (under the cover of instituting the corridor system). At the end of October 2018, Banking loan portfolio was at Php 7.78 trillion 55.5% above the Php 5 trillion at the close of 2015.
The flattening curve, aggravated by the plummeting M3, not only exposes liquidity issues but also credit strains within the banking system. It also brings forth funding issues for the NG’s very ambitious deficit spending.
When the FSR admitted that “shocks that have caused dislocations of crisis proportions have come as a surprise”, they weretalking about constraints on the system that had been a lot less than today.
Or, none of the present market developments has alleviated such “shocks”. To the contrary, ‘shocks’ have gotten much worse.
And this tells us why the Insurance Commission had to bailout preneed firms by easing regulatory reporting standards. [SeeInsurance Commission Launches Regulatory Bailout of Pre-Need Firms, The Twin of Unbridled Fiscal Spending is High Inflation, The Coming Stagflation November 18, 2018]
And this shows to us why banks have been aggressively soliciting funds from the public.
From last week’s disclosures:
The maiden bond issue of UnionBank of the Philippines [PSE: UBP] has received overwhelming investor demand. With this, the bank has now more than doubled its issue size from the originally announced PHP5.0 billion to PHP10.5 billion. The 2-year fixed rate bonds, which have a coupon rate of 7.061% per annum to be paid quarterly, were priced at 30 basis points over the 2 year BVAL government benchmark rate on November 21, 2018. This is at the lowest end of UnionBank’s indicative pricing guidance of 30 to 50 basis points that the Bank communicated during a multi-city roadshow in Manila, Cebu and Davao last November 13-15, 2018. With the issue size already over twice covered, UnionBank also opted to shorten the public offer period almost a week earlier than expected.
Yield to Maturity at which Additional Bonds under Metrobank’s [PSE: MBT] 2-year 7.15% Coupon Fixed Rate Bonds Due 2020 (“Bonds”) will be issued. (Reissuance out of the Php 100 Billion Bond and Commercial Paper Program)In consultation with Standard Chartered Bank as the Sole Arranger, Metrobank will issue the Additional Bonds at a Yield to Maturity of 7%. The Additional Bonds will be offered to the public from November 28 to December 7, 2018. Issue Date will be on December 17, 2018. Metrobank is targeting to add at least Php5 Billion to the existing Bonds.
Lastly, again from the FSR: “What is not debatable is that repricing, refinancing and repayment risks (3Rs) are escalated versus last year and this could result in systemic risk if not properly addressed in a timely manner”
Will the present path of tightening suffocate the economy that “results in systemic risk”? Or will the BSP set loose its grip on the financial system to unleash inflationism once again? Will the coming declines in the CPI serve as its trigger?
