Governments resist austerity. Politicians buy votes with spending. But because they do not control their domestic currency systems in Europe, they must rely on borrowing and taxes to fund their spending. They cannot call their respective central banks and demand that the banks buy bonds by means of newly created fiat money. This puts them at the mercy of bond buyers, who are notoriously unmerciful. They have their own bond vigilantes. These investors can veto plans of politicians by refusing to lend at low interest rates. By holding out, they force the politicians to pay higher interest rates. Politicians hate that. If rates go too high, this can cause a recession. Politicians prefer to conceal this by having a central bank become the lender of last resort—Gary North
In this issue:
Treasury or Bond Vigilantes Return with a Vengeance, Compels the BSP to Implement its First Rate Hike!
I. Treasury Vigilantes Compel the BSP to Implement its First of a Series of Rate Hikes!
II. Why is the BSP Dithering to Tighten?
III. HTM Shoots to the Moon as Banks Conceal Trading Losses! Q1 2022 Accounting Profits Up 26%
IV. Tightening Liquidity: Bump on Money Supply Growth? Public Spending Spree? Treasury Vigilantes are Back with a Vengeance!
Treasury or Bond Vigilantes Return with a Vengeance, Compels the BSP to Implement its First Rate Hike!
I. Treasury Vigilantes Compel the BSP to Implement its First of a Series of Rate Hikes!
The BSP finally relented. It reluctantly raised its policy rates by 25 bps last Thursday, May 19th.
The 25 bps, which represent a baby step, signals its reluctance.
Before this, the BSP used the signaling channel to broadcast its proposed action.
Excerpted from several articles are the rationalizations for its actions. (all bold mine)
GMA News, May 18: Bangko Sentral ng Pilipinas (BSP) Governor Benjamin Diokno has indicated that there is now less space for an accommodative monetary policy, but any changes should be conducted in a timely manner. Diokno on Wednesday said that while inflation pressures have been linked mainly to supply-side factors, which are best addressed by non-monetary interventions, secondary effects are starting to manifest. "The space for maintaining an accommodative policy stance has considerably narrowed given how the April 2022 inflation of 4.9% settled near the higher end of the BSP's forecast range," he said.
Inquirer, May 19: BSP Governor Benjamin Diokno on Wednesday noted that headline inflation, after having breached the target band of 2 percent to 4 percent in April at 4.9 percent year-on-year, is expected to remain higher than desired. At the same time, Diokno said that along with the higher-than-expected 8.3-percent growth rate of Philippine gross domestic product in the first quarter, second-round effects—particularly wage hikes—were starting to manifest themselves.
Last March, we noted that…
The BSP adamantly refused to budge from its historically low rates stance because of the following perceived advantages: to sustain the rescue of the banking system via repressed deposit rates, increase bank credit transactions, bloat the GDP, expand prospects of higher tax collection, subsidize the government and borrowers through a negative "real" rates regime (financial repression), and contain the FX exchange rates.
Keeping policy rates at a historic low is a function of politics primarily, before economics.
By putting a cap on the rise of the CPI, the BSP hoped to contain interest rates from rising.
See Despite Lower September CPI, Philippine Treasury Yields Soar, Spreads Steepen! Greenflation Implodes the ESG Bubble! October 10, 2021
See Cracks on the BSP’s Credibility: Treasury Yields Flatten! PLDT to Take Defensive Posture from Higher Debt and Financing Costs March 27, 2022
Figure 1
As we would argue, always check the treasury markets!
We barely hear from them; rather, we see their actions.
The sustained selloff or the surging yields exhibits that the treasury markets have (totally) ignored or dismissed the CPI data of the PSA.
More significantly, it has exposed the BSP as blatantly "behind the curve." (Figure 1, highest pane)
The spread between the benchmark 10-year PDS yield and the official repo rate has soared past the 2018 highs! The treasury markets have priced in the CPI as exceeding the September and October 2018 highs of 6.7%!
In 2018, the panicked BSP responded dramatically to the surging yields with a 175 bps hike in 7-months! Yes, seven months. It is why some predict the BSP would hike by as much.
But again, the spreads and the level of debt are beyond this level. The economic and financial conditions are likewise dissimilar. (Bank bailout measures tell us more on this) The thing is, this is not 2018!
Further, the effectiveness of zero-bound rates as a rescue measure for the banking system has been fading.
Rising 10-year yields have filtered into the diminishing deficit of bank interest expenses. Deflation in bank interest expenses slowed to 10.7% YoY in Q1 2022 from 34.7% YoY in Q4 2021. (Figure 1, middle pane)
Or, rising yields also expose the diminishing returns of the BSP subsidies represented by zero-bound rates on the banking system.
In short order, the Treasury markets have been driving the policies of the BSP more than the other way around!
And unless the BSP gets ahead, street inflation will only escalate.
In the 80s, independent analyst Ed Yardeni once coined the term bond vigilantes, describing the bond markets' demand for higher yields to protest monetary or fiscal policies.
The Treasury vigilantes are putting a kibosh on both of them.
II. Why is the BSP Dithering to Tighten?
The simple answer: higher rates will expose malinvestments.
Responding to the BSP announcement, led by the 2-year, short to medium-term bonds, spiked the most. (Figure 1: lowest pane)
In this respect, the BSP has yet to persuade and placate the treasury markets that it has the mettle to take the plunge.
And it is logically awkward to pin the blame on the supply side when it has been touting the GDP performance of the last two quarters to 'domestic demand.'
So the driver for the GDP is 'domestic demand' while the CPI is 'supply'? And real GDP is calculated to include the effects of the CPI? That's an example of putting a square peg in a round hole! Awesome logic.
And their premise is that election and other public spending measures, and the recent growth in bank credit, are factors isolated from demand.
As a side note, here is what we wrote on public spending in April… (emphasis original)
But our hunch is that deficit spending will be most aggressive on the candidates backed by the most vested interest groups.
See Deficit Spending Remains a Core Agenda, The Significance of Public Debate of Candidates for the National Leadership April 4, 2022
Clearly, the political division of economic spoils is coming.
Inquirer, May 19: The 19th Congress is eyeing to pass a stimulus bill titled “Bayan Bangon Muli (BBM)” as well as reschedule the barangay elections set this December in order to save P8 billion which could be used to fight the pandemic.
That should signify the appetizer. See below for further discussion.
But why is the BSP dithering?
The banking system remains on the BSP lifeline. The BSP's operational and regulatory relief measures for the industry remain in place.
The BSP extended the applicability of these measures until December 2022.
That said, the financial conditions of the industry, as published by the BSP, are not the same relative to the pre-pandemic era. It would represent a categorical error to compare (improved) present conditions with the past.
So the leniency in reporting and regulatory supervision or the dramatic easing in the regulatory regime sugarcoats its actual conditions.
More importantly, such politically induced rescue efforts foster a moral hazard and dependency problem for the industry.
We cited this in February…
Risks are not extinguished by statistical camouflaging. Instead, the lack of transparency magnifies it.
The World Bank enumerated some factors that drive institutional risks from such forbearance policies: The lack of transparency increases the opacity and complexity of public balance sheets. It weakens trust that may lead to diminished investments. And it may delay the resolution of non-performing loans, thereby decreasing the capacity of financial institutions to lend to creditworthy borrowers.
But the World Bank missed the more important ones: Moral hazard, dependency, and corruption. These ethical issues may metamorphose into technical issues.
See Kaboom! The World Bank Warns of Hidden Risks in the Philippine Financial System! February 20, 2022
In short, aside from liquidity injections, the BSP camouflages the increased fragility of the banking system through lax surveillance and reporting or its rescue policy of non-transparency.
Figure 2
Its hesitance to normalize rates also represents the rear-view mirror effect.
Raging street inflation, mainly through the rice crisis, pulled down bank lending in 2018. (Figure 2, upper window)
Net NPLs accelerated upwards along with the surge in Treasury yields in 2018. (Figure 2, lower pane)
In essence, higher rates expose the facade of a supposedly "sound macro-economy!"
III. HTM Shoots to the Moon as Banks Conceal Trading Losses! Q1 2022 Accounting Profits Up 26%
And there is more.
There have been unintended consequences to its zero-bound policy on the banking industry.
Figure 3
In 2018, the use of held-to-maturity (HTM) assets to disguise mark-to-market losses soared. And yes, even while 10-year yields haven't reached 2018 watermarks, HTM assets in Q1 2022 have skyrocketed! (Figure 3, highest pane)
It presently transcends the 2018 levels!
And that's because banks have shifted their core operations from lending to speculation. That's aside from their joint efforts with the BSP to finance public debt.
The share of investments to total assets has rocketed to a 10-year high of 28.68%. (Figure 3, middle window) Yet, despite the record investments, market losses continue to mount.
Accumulated market losses swelled to a record Php 54.6 billion in March 2022. And that excludes the HTMs! (Figure 3, lowest window)
Figure 4
Nonetheless, banks posted a 26% YoY increase in profits from lower deposit expense subsidies, higher interest rate margins, and higher lending and non-interest income from fees and commission. (Figure 4, topmost pane)
The record swelling of HTMs helped siphoned cash off the banking system, which suffered an 11.8% deflation in March. (Figure 4, middle pane)
Moreover, the BSP embarked on pruning its QE.
GMA News, May 20: More than a month before the Duterte administration steps down, the national government has paid in full its P300-billion loan with the Bangko Sentral ng Pilipinas (BSP) on Friday morning, the Department of Finance (DOF) said. In a statement, the DOF said the national government settled the P300-billion provisional advances to the central way ahead of its actual maturity date of June 11, 2022.
From the end of 2021, BSP net claims on the central government diminished by Php 387 billion last March. The BSP further reduced Php 99 billion for an accrued Php 486.8 billion YTD. (Figure 4, lowest window)
The rate of growth of the net claims on the central government through banks also slowed.
The liquidity reduction operations by the BSP and banks also reduced deposit liabilities, evidenced by the sharp slowdown in peso deposit growth.
Deposit liabilities, the primary source of bank lending, expanded 7.15% in March, its lowest growth rate since July 2021.
Peso liabilities, which also grew by 6.51%, an October 2019 low, pulled it lower.
Meanwhile, FX deposits are surging. It expanded 10.9% in March, its fastest rate since May 2018.
Is the public seeking a haven via a shift from the peso to FX deposits?
IV. Tightening Liquidity: Bump on Money Supply Growth? Public Spending Spree? Treasury Vigilantes are Back with a Vengeance!
Figure 5
Despite the massive growth in cash in circulation to finance election spending, M3 growth appears to have stalled, and its growth rate may have plateaued since the 3Q 2021, which further points to a tightening liquidity backdrop. (Figure 5, topmost pane)
The Treasury vigilantes have also been confirming this view.
With the 5-year yield rising faster, the spread of the 20- and 5-year continues to exhibit a narrowing. From the belly or 5-year bonds, the treasury markets are exhibiting symptoms of a bearish flattener! (Figure 5, middle window)
Not only are we going to see a shift in the fundamental economics of credit, but repricing, collateral, and counterparty issues will all come into play.
Once again, with public spending and fiscal deficits drifting at record levels, financing these should be a spectacle. (Figure 5, lowest pane)
Or, with the BSP trimming its support momentarily, how will the incoming regime finance its proposed signature 'stimulus'?
Will they increase competition with banks and non-financial institutions for access to public savings at a much higher rate than the present?
Unless one believes in economic unicorns, how should this 'crowding out' transpose into economic growth or advancement?
The treasury vigilantes have, once again, been showing the opposite of the consensus view on the economy.
At day's end, there is no such thing as a free lunch.
The treasury/bond vigilantes are back with a vengeance!
And they appear to be on the path of imposing rigorous discipline on the political economy and the markets, substantially distorted by the free lunch premised Keynesian policies of the BSP in support of the neo-socialist (neo-fascist) state.
Yours in liberty,
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