Faith is my sword. Truth is my shield. Knowledge my armor. — Dr. Stephen Strange, "Shadows & Light Vol. 2"
In this issue:
Lower November CPI to Justify the BSP’s Record Low Rates Regime: Paraphrasing J. Carville, It is the Elections, Stupid!
I. Lower November CPI? Why Did the Bureau of Treasury Reject Bond Offers?
II. The Growing Dependence of Monetary/Financial Liquidity to the GDP
III. BSP’s Insistence to Maintain Repressed Rates: Paraphrasing James Carville: It’s the Elections, Stupid!
IV. Divergent (Inflation) Input Prices and Manufacturing Outlook: Whose Data is Correct, the PSA or the IHS Markit?
V. Philippine Treasury Markets: Escalating Liquidity Strains
VI. BSP Rescue Measures: Bank Industry’s Moral Hazard in Action! The Political Drift Toward Neo-Socialism
VII. What the Tantrums in the Treasury Markets Imply: There is No Free Lunch
Lower November CPI to Justify the BSP’s Record Low Rates Regime: Paraphrasing J. Carville, It is the Elections, Stupid!
I’ll start this outlook with this poignant, timely, and highly relevant quote from Austrian economist Roger Garrison. (all bold, underline and italics in this analysis are mine)
The Federal Reserve might lower interest rates (by targeting a low federal funds rate) in circumstances where there has been no change in the underlying market conditions. With unchanged technology, resource availability and consumption preference, business firms are led nonetheless to take advantage of cheap credit. Production activities, particularly in interest-sensitive sectors of the economy, appear more profitable. The economy is steered by low interest rates onto an unsustainable growth path. The cheap-credit policy, though ultimately harmful to the economy, is politically attractive. A seemingly strong economy always makes an attractive backdrop for office holders seeking re-election. If the timing is right, the votes can be harvested before the seeming strength is revealed by the market itself to be an actual weakness.
Roger W. Garrison, Natural and Neutral Rates of Interest in Theory and Policy Formulation, Quarterly Journal of Austrian Economics, Mises.org, December 8, 2021
I. Lower November CPI? Why Did the Bureau of Treasury Reject Bond Offers?
In the morning of December 7th, authorities declared a follow-up decline in the November CPI.
From the Reuters, December 7: Philippine inflation in November eased to the lowest level in four months, supporting expectations that the central bank will keep its benchmark interest rates steady at its last meeting this year to support an economic recovery. The Bangko Sentral ng Pilipinas (BSP), which has kept the rate on the overnight reverse repurchase facility (PHCBIR=ECI) at 2.0% since November last year, will review its policy settings on Dec. 16. The Consumer Price Index rose 4.2% last month from a year earlier (PHCPI=ECI), down from a 4.6% rise in October, due to a slowdown in price increases for the heavily weighted food and non-alcoholic beverages index. The headline figure was above the central bank's projected range of 3.3%-4.1% for the month, and higher than the 3.9% median forecast in a Reuters poll.
Late in the afternoon, media reported that the bond auction at the Bureau of Treasury failed.
From the Inquirer.net, December 7: The Bureau of the Treasury on Tuesday (Dec. 7) rejected all bids for P20 billion in reissued 10-year bonds it offered as the market sought high rates. Despite P42.4 billion in tenders, which made the auction more than twice oversubscribed, bid rates averaged a higher 5.071 percent for the debt paper that would mature in nine years and seven months. When first sold last July, these IOUs fetched a coupon rate of 4 percent. So far, the Treasury raised a total of P189.9 billion from this bond series. National Treasurer Rosalia de Leon said the Treasury fully rejected the elevated bids as inflation already decelerated for three straight months. Headline inflation of 4.2 percent year-on-year in November, however, remained above the Bangko Sentral ng Pilipinas’ (BSP) 2 to 4 percent target range of manageable price increases. Also, De Leon noted that BSP Governor Benjamin Diokno “consistently expressed that accommodative stance”—or low interest rates—”will stay to support recovery.”
If traders believed in the CPI numbers, why send a bid on treasury bonds at high rates, which prompted a rejection from the Bureau of Treasury?
Yields of 2 to 10-year treasuries soared on the same day but most tumbled in the last two trading sessions of the week.
Figure 1
At the close of the abbreviated week, the treasury yield curve partially steepened. (Figure 1 upmost pane)
The run-up of upside run by the yields at the belly of the curve paused. On the other hand, the 7- and 10-year Treasury yields rose.
II. The Growing Dependence of Monetary/Financial Liquidity to the GDP
Why should this be of any interest to us?
That is because changes in interest rates influence credit transactions that affect the economy and the financial markets.
According to the BSP, the benchmark money supply M3 accounted for 76.5% of the GDP, slightly off the 77.7% record in Q1 2021. Cash and demand deposit or M1 accounted for 30.5% of the GDP, also marginally off from the record 30.7% in Q1 2021.
The banking system is the primary source of liquidity generation or money supply growth, followed by the BSP. That said, credit is the lifeblood of the modern economy. (Figure 1, middle pane)
The long-term uptrend of the money supply growth to GDP reveals the increasing dependency of the economy on the uptake of credit. The rescue measures instituted by the BSP in the pandemic only intensified this relationship.
Thus, the BSP’s liquidity operations took over when bank lending stalled from 2018 to the present. Before 2018, the banking system was the main engine of liquidity generation. The net claim share of M3 has risen as the Financial share of M3 dropped. (Figure 1, lowest pane)
Yes, this shift occurred before the pandemic, which effectively demonstrates that the pandemic force majeure provided the camouflage for the BSP to launch a massive rescue of the embattled banks!
The systemic leverage data also reveals such juggling of credit flows.
Figure 2
System credit, comprised of (universal and commercial) bank lending plus outstanding public debt, has reached Php 20.99 trillion in October! That’s about 115% of the annualized 2021 GDP! The data omits capital market borrowings and informal credit or the shadow banking system. (Figure 2, upmost pane)
Further, October data showed a 12.2% YoY growth. So, in effect, the slack in bank credit transactions since 2018 has been replaced by public borrowings from savers. The result of this shift in this liquidity generation mechanism is not only a transfer from savers to the banks and the government. Importantly, it demonstrates the crowding out of resources that leads to capital consumption.
Even PSEi 30 earnings have become increasingly strained by the feedback loops of debt: debt growth as the main engine of revenue and earnings growth!
Debt strains have become so evident that the BSP has noticed it! Yes, the following excerpt is from a pre-pandemic era report!
Once again, from the BSP’s Financial Stability Report H1 2018 to H1 2019 (p.13): Based on the audited financial statements of the 148 Philippine Stock Exchange (PSE)-listed non-financial corporations (NFCs), the growth of interest expense (IE) has outpaced the rise of earnings before interest and taxes (EBIT). In addition to the rate of growth, the ratio of IE to EBIT shows a rise from 14.5 percent at the start of the first quarter of 2016 to 22.6 percent as of March 2019, with a high of 27.8 percent in December 2017. The same companies have also reported lower profitability with respect to return on assets.
And as previously shown, debt continues to mount despite the economic conditions! Still, the mainstream repeatedly hardwires us to believe that all is hunky-dory!
Yet, barely has there been a discussion of the aggregate credit and liquidity data as the mainstream fixates on the superficial features of the GDP.
It is as if such BSP-provided numbers are nonexistent! Further, adding to this uncertainty is its accuracy.
"Reopening" is the de rigueur Overton window or the permissible "window of discourse" of contemporary economics.
III. BSP’s Insistence to Maintain Repressed Rates: Paraphrasing James Carville: It’s the Elections, Stupid!
Media, backed by the mainstream experts, touts whatever the officials declare as sacrosanct.
As the article above noted, the BSP chief consistently expressed that accommodative stance”—or low interest rates—”will stay to support recovery.”
But has it?
Markets determine the direction of policies and not political assertions masquerading as policy thrust.
Evidence? The divergence between the markets and the BSP policies has only magnified. (Figure 2 middle pane)
Yields of the Philippine 10-year bonds continue to scale higher against the historically low overnight policy rates of the BSP and the faltering CPI. (Figure 2 middle pane)
Or, in contrast to their analysts, the unassuming institutional treasury traders continue to position against the trajectory laid out by the CPI and the BSP!
It stands to reason that treasury traders continue to pressure the BSP to raise rates!
The market’s response shows that the BSP has been behind the curve.
With monetary policies lagging, the markets indicate symptoms of policy error that only build on the imbalances that will surface soon.
Parts of the treasury markets have already been manifesting seminal symptoms of liquidity stress!
And the incentive to force rates lower has been articulated in the opening quote from economist Roger Garrison.
Paraphrasing ex-US President Bill Clinton's political strategist James Carville famous quote, "it's the elections stupid!"
IV. Divergent (Inflation) Input Prices and Manufacturing Outlook: Whose Data is Correct, the PSA or the IHS Markit?
So, while authorities can print whatever CPI and GDP numbers it desires to attain their political agenda, it will not escape the consequences of their present and past actions.
As previously predicted, authorities will likely manufacture outstanding statistical numbers to win votes in the coming national elections and extend their stranglehold of power. And these will be backed up by the historically low policy rates of the BSP.
The lower-than-expected CPI provides the monetary authorities the convenience of MAINTAINING its current monetary policy stance, which delivers several substantial political-economic benefits.
First and foremost, such policies allow the sustained bailout of the banking system. For example, deposit expenses of BDO and MBT in the 3Q plunged by 43.5% and 31.9%, respectively. With lending down, that’s where the gist of bank profits or reduced losses come from today. But such subsidies are barely mentioned by the media.
Next, by keeping rates below the CPI, the negative real rates or the inflation tax subsidizes borrowers, particularly the National Government, banks, and their elite clients, coming at the expense of savers. Negative real rates are at a record.
Also, another intended effect of such implicit tax on saving is to help boost the GDP by bolstering bank lending and spending.
Another, calculated through the PCE component of the GDP, a lower CPI amplifies the GDP.
Since the CPI constitutes a principal factor in contributing to changes in the interest rates, a manageable CPI may lower or stabilize interest rates level that diminishes credit risks.
It also helps reduce credit and currency risks of the country’s mounting external debt exposure channeled through a strong peso.
Ayala Land’s Fabulous 3Q Growth Exposed, Fintech Driven PLDT Boom? Treasury Yields Spike as October CPI Slows, November 7, 2021
Figure 3
Real-time treasury prices against statistics and policy have not only accounted for statistical disparities, but private sector statistics have also departed from government data.
For instance, the PSA’s manufacturing input prices finally emerged from a 30-month deflation by posting a .1% increase in October. The bizarre part is that a boom is supposedly in progress! (Figure 3, upmost window)
However, the IHS Markit has a remarkably different perspective for November, the same dynamics from months ago!
Central to the uptick was an expansion in new orders received by Filipino manufacturers, with new sales rising for the first time since March. Higher client numbers, increased footfall, and a general improvement in customer demand were the key drivers of growth, according to panellists. The rate of growth was subdued in the context of the series history, however. At the same time though, manufacturers recorded an eighth monthly decline in production, albeit one that was only fractional. While stronger sales helped some businesses to expand their output, others mentioned delays receiving inputs, as well as material and staff shortages constrained capacity. Traffic issues, port congestions and difficulties sourcing materials influenced another deterioration in vendor performance during November. The extent to which lead times lengthened was marked, but eased during the month. Meanwhile, workforce numbers continued to fall, though only modestly and at the softest pace for four months. Respondents often cited that voluntary resignations led to the decline, but firms also reportedly found it difficult to source skilled replacements. Despite this, backlogs of work fell sharply, and at a quicker pace. Anecdotal evidence suggested that firms were able to keep up with demand as employees worked overtime to complete existing orders…. On the price front, input costs rose during penultimate month of the year, extending the current period of inflation to 19 months. The rate of increase quickened to the sharpest since March 2018 and was among the steepest in almost six years of data collection. Panel comments often linked the surge to higher raw material, transportation and energy costs. Selling charges also rose, and at a quicker pace as firms sought to pass-through higher expenses.
Here is a concise rundown: subdued sales growth, eight-month of output contraction, the continued shedding of workers (though at the softest pace for four months), rising input prices for 19-months (with a quickened pace in November!), and output price increases at a quicker rate!
Again, the manufacturing conditions narrated by the IHS Markit of the manufacturing conditions have sharply departed from the numbers of the PSA!
The Markit describes a stagflationary scenario while the PSA suggests a low inflation-based boom!
Resonating the late US President John F. Kennedy’s response to the divergent reports from his two advisers on Vietnam, "You two did visit the same country, didn't you?"
Have the PSA and the Markit been describing conditions of different countries?
Which of the two surveys has accounted for the nearest representation of reality, the PSA or IHS Markit?
V. Philippine Treasury Markets: Escalating Liquidity Strains
As noted above, substantial segments of the Philippine Treasury markets have been pushing back against the BSP’s policies.
That is, the BSP chief might be right after all for the wrong reasons. The CPI may go down by some more. But this is because symptoms of liquidity strains have emerged.
And the likely outcome may not reflect the bullish scenario they project.
There was little effect on the recent yield spread collapse from this week’s marginal steepening in the bond markets as exhibited by the 20-5 year spread. (Figure 3 middle pane)
And this should be bad news to the fans of the PSEi 30. It tells us that index managers may be about to run out of ammunition for their orchestrated pumping operations.
Figure 4
A sharp drop in volume has accompanied this week’s 1.94% rally, which emerged amidst a negative breadth. (Figure 4, upmost pane)
The declining rate of growth of the cash reserve of the banking system has likely been part of the story. The correlation: when cash reserve growth rises, treasury yields fall and vice versa. (Figure 3, lowest pane)
After the massive injections from the BSP in 2020, surplus cash in the banking system seems to exhibit signs of dissipation.
So, banks have begun to tap the capital markets for their funding. Following Metrobank’s Php 19 billion bond offer last June, BPI announced a Php 5 billion offer in January last week.
Banks will again compete with the government and several listed non-banking firms in the capital markets for access to savings.
With a slowing trend of deposit growth, this should put pressure on borrowing rates.
Yes, bank lending rebounded in October (+3.71%), but following the recent bounce, peso deposit growth (+9.28%) and money supply growth (+8.24%) appear to have slowed! (Figure 4, middle pane)
The scars of the recession mean that monetary operations of BSP, public works of the National Government, and borrowings by the firms of the elites have been responsible for the current spate of deposit growth.
VI. BSP Rescue Measures: Bank Industry’s Moral Hazard in Action! The Political Drift Toward Neo-Socialism
And here’s the thing.
As previously stated, the BSP’s momentous policies have drastically reshaped the operations of the banking system.
Bank lending to the financial sector significantly boosted the banking system’s overall credit growth in September and October. Bank lending to this sector accounted for 10.98% of the total loans to the industry last October. (Figure 4 lowest pane)
The outgrowth of inter-industry lending has coincided with the massive pumps in select PSEi 30 issues that pushed its level past 7,000.
Figure 5
Nota bene: The massive rescue of the banking system has skewed the industry's statistics. Current conditions are very different from the pre-pandemic era. Hence, comparing data with the past can be analogized to apples to oranges or false equivalence. Maybe the analogy of a human to a Frankenstein comparison would be better. Imagine banks registered profits in the 3Q 2021 even when interest and non-interest income or core operations posted deficits! That's the magic of statistics!
But there’s more.
To combat asset and collateral prices against price deflation, the BSP launched a historic liquidity program that spiked its balance sheet by about 60% or Php 2.996 trillion from January 2020 to October 2021.
The present rally in the PSEi 30 can be attributed primarily to the BSP's unprecedented liquidity injections and relief operations. (Figure 5, upmost pane)
Needless to say, the BSP’s policies engineered the massive rally of the PSEi 30 from its March 2020 nadir, which translates to the unprecedented rescue of the banking system and the capital markets controlled by the elites!
In the face of recession, negative rates propelled banks to use excess liquidity provided by the BSP to gamble with asset prices. (Figure 5, second to the highest window)
But such massive rescue translates to vast mispricing of assets and the massive buildup of distortions or misallocation of finances and resources.
But nothing exists in a vacuum. The BSP negative real rates policies reorient people's values and preferences.
These are manifested not only in economic and financial transactions but also in social activities.
Thus, the BSP's policies have spurred unwarranted fixation for short-term gratification from asset bubbles, which mirrors the populist political 'free money' drift towards neo-socialism.
Unfortunately for the establishment, the bond markets are pushing against these imbalances.
As the former UK Prime Minister Margaret Thatcher once said, "The problem with socialism is that you eventually run out of other people's money."
VII. What the Tantrums in the Treasury Markets Imply: There is No Free Lunch
Again, the policy of free lunches appears to be fading. The Treasury markets have been pushing this scenario.
If the bearish flattening persists, the interest margins of the banking system should narrow, compounding on current pressure on bank profits.
It also reduces the incentives of banks to lend, especially under the current uncertain conditions.
Worst, the interest margin squeeze and higher rates should reduce loan demand, escalating challenges in the economy.
Despite the historic relief measures still in place, a slowdown in bank lending will likewise magnify credit risks. Such risks are likely to get reflected as impairments in the bank's balance sheets. (Figure 5 second to the lowest pane)
Although NPLs have turned lower in October, banks continue to increase their loan loss provisions but at a reduced pace. (Figure 5, lowest pane)
Higher rates should also reduce the monetary subsidy of the BSP to banks through deposit expenses.
Rising yields amidst the decline in the CPI or the diminishing negative (real) rates effectively erodes the subsidy to the government, banking sector, and their primary borrowers, the elites.
Shrinking monetary liquidity from the above likewise amplifies the risks of asset deflation.
Sure, the CPI may fall. But economic recovery will falter.
And banks will become more dependent on the BSP for their operations.
Proof?
From the Businessworld, December 9: THE PHILIPPINE government will be asking the central bank for P300 billion in liquidity support next year, less than the previous loan after the country’s economic outlook improved, the Finance chief said. In a letter to the Bangko Sentral ng Pilipinas (BSP), Finance Secretary Carlos G. Dominguez III said the government would make the request as a provisional advance in the second week of January.
The National Government serves as a convenient political pretext for the BSP liquidity operations to banks.
As said last November…
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.
Bank Bailout: BSP Retains Policy Rate; Hello Stagflation! Fastest Plunge of Treasury Spreads (20 & 5 years) Since 2014! PSE Bank’s 3Q Performance, November 21, 2021
At the end of the day, the current policy regime only incentivizes redistribution through 'socialize losses and privatize profits.' Such an environment should aggravate diminishing productivity and enhance capital consumption.
But worry not. The incumbent will likely be inclined to ensure that economic and financial statistics and repressed policy rates will vindicate their policies.
After all, as they say, it is the elections, stupid.
Lastly, since BSP seems to embrace the law of instruments where "if all you have is a hammer, everything looks like a nail," it will address any signs of economic weaknesses with liquidity infusions.
Yours in liberty,
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