CPI is a contrived goods/services basket that is perennially changed. The only legit way to assess inflation is via living standards. Higher prices for necessities w/out equally higher wages = lower living standards. And that's where we are heading, whether CPI shows it or not—Simon Mikhailovich
In this issue
Market Response to the May 5.4% CPI: Liquidations in the Peso, Treasury Markets, and the PSEi 30!
I. Spinning Inflation as Economic Growth
II. CPI Response: Financial Liquidation, The Philippine Peso Falls to a 3.6-year Low!
III. CPI Response: Financial Liquidation, Treasury Markets Fall/Yields Rise Further!
IV. Stagflation Ahoy! Profit Margin Squeezes!
V. Widespread Diffusion of Price Pressures: Factories Race to Hoard and Produce!
VI. Mounting Policy Risks from the BSP’s Seriously "Behind the Curve" Policies!
VII. CPI Response: Financial Liquidation, PSEi 30 Endured a 3.14% Weekly Plunge! Higher Rates a Bane to the Property Sector
Market Response to the May 5.4% CPI: Liquidations in the Peso, Treasury Markets, and the PSEi 30!
I. Spinning Inflation as Economic Growth
First, in 1Q 2022, authorities claimed that the economy was ablaze.
But then, a survey conducted by a private sector pollster noted that "self-rated poverty" also increased.
Likewise, sales of listed food and retail chain titans showed growth from a "low base effect," or comparing an economy hobbled by lockdown with a "reopened" economy. Based on the peso sales, there have hardly been any massive improvements, implying that what the mainstream sees as "growth" signified a statistical charade.
See Q1 2022 Consumer Spending Boom? Revenue Performances of PSE Listed Food and Retail Diverges from GDP! May 29, 2022
Last week, the same pollster observed that hunger incidence rose over the same period.
Metro Manila, June 6 (SWS)—The national Social Weather Survey of April 19-27, 2022, found that 12.2% of Filipino families, or an estimated 3.1 million, experienced involuntary hunger – being hungry and not having anything to eat – at least once in the past three months. The April 2022 Hunger rate is 0.4 points above the 11.8% (estimated 3.0 million families) in December 2021, and 2.2 points above the 10% (estimated 2.5 million families) in September 2021 However, it is 0.9 points below the 13.1% annual average for 2021
If the economy is recovering robustly, why are a substantial number of people rating themselves as "poor," which appears to correspond with the rising accounts of hunger incidences?
Further, tied to the above, authorities say there was a surge in statistical inflation or the CPI to 5.4% last May.
Metro Manila, June 6 (Businessworld)—Growth in prices of widely used goods and services quickened to its fastest pace in over three years in May due to higher food and transport costs, the government reported this morning. Headline inflation in May surged by 5.4% year on year from 4.9% in April and 4.1% a year ago, preliminary data from the Philippine Statistics Authority showed.
Had the 2012 base year been used, May's CPI would have reflected a higher rate of 5.9% or 6%.
A higher CPI rate would have prompted the BSP to take more aggressive than the present baby steps.
Since there is neither competition nor audit, it may be futile to engage in questioning the validity of this number.
One thing is clear, though.
Despite the lack of breadth of the data and its suppression, the CPI is on an uptrend.
Authorities have limited the publication of the 2018-priced CPI data from 2018 onwards, providing the public a limited 3+ years perspective only.
Or, contra the consensus, its streak of increases does not represent 'transitory.'
Instead, we rely on the markets to deliver the verdict.
And in response to the CPI, liquidations have plagued the peso, the treasury, and the stock markets!
II. CPI Response: Financial Liquidation, The Philippine Peso Falls to a 3.6-year Low!
Figure 1
The USD Php is on a roll.
Since its breakout from the 52.5 level a week ago, it rose by another .26% this week to reach Php 53, a 3.6-year high!
The sustained selling of the peso indicates that currency traders see the CPI as an inadequate measure, or they foresee a higher CPI going forward.
From a different angle, the trend of the peso-USD is DOWN. And it will remain down with likely an accelerated momentum going forward.
While the Wall Street maxim "no trend goes in a straight line" should eventually apply, the present impulse and the underlying fundamentals support a higher USD-Php over time.
We pointed out earlier that the rising rates globally may have prompted the BSP to reduce its tools to support the peso.
As repeatedly pointed out here, the recent strength of the peso emanates from artificial means. It relies on leveraging or extensive exposure to "USD shorts."
See USD-Php Races to a Two-Year High! The Fragility of USD Shorts Mounts, June 5, 2022
The BSP reported a 3.5% YoY drop in the Gross International Reserve (GIR) last May to USD 103.5 million, an October 2020 low.
We don't need to repeat our case against the peso.
Nevertheless, aside from raging inflation abroad, the weak peso should aggravate further domestic inflation, intensifying the feedback loop mechanism.
III. CPI Response: Financial Liquidation, Treasury Markets Fall/Yields Rise Further!
Figure 2
The Treasury markets continue to ignore or discount the CPI data.
Traders have consistently been pricing a higher CPI, which was no different this week as BVAL yields rose across the curve, excluding the 1-year note. (Figure 2, highest window)
Rising yields translate to the sustained selloffs in the Treasury markets.
The spreads of BVAL 10-year and 3/6 months scaled upwards since 2019 and have barely looked back, despite the slowdown in the CPI in early 2022. (Figure 2, middle window)
So while authorities tried to persuade the public that they were on top of the CPI, traders saw through such bluffs and sold bonds that widened the spreads or steepened the treasury slope.
Though authorities try to pin the blame solely on supply-side pressures, people who understand economics know that supply shocks won't lead to widespread dispersion of price increases.
The thing is, supply can't stand on its own without the corresponding demand.
Furthermore, mispricing from such dynamics isn't sustainable unless political interventions instigate it.
The cumulative interventionist policies have spurred a disruption in the global division of labor. These include the response to the pandemic, the Green energy agenda, intensifying mercantilism, the weaponization of the USD, and more.
Unless one believes in free lunches, the record liquidity infusion by the BSP will have repercussions. And the BSP knows it.
Proof?
Metro Manila, BSP*—More liquidity though can create its own challenges. The injection of liquidity is an adrenaline to the system to counter the slowdown brought about by the crisis. But there is always that concern that too much liquidity will fuel inflation, and that high inflation can be persistent rather than transitory. This is the debate that we hear more in AEs. It reflects the balancing act between the benefits today of add-on liquidity versus the risks tomorrow of retaining too much of it. [bold added]
*BSP, Financial Stability Report (second semester 2021), p.5, BSP.org
Contemporary measures of liquidity are just off the record highs in Q1 2022. (Figure 2, lowest pane).
So benefits can only accrue from historic money pumping (partly for elections and bank rescue efforts), with no costs on the horizon?
Really?
And the uptrend in inflation, rooted in 2015, represents solely supply problems?
IV. Stagflation Ahoy! Profit Margin Squeezes!
Please take a look below at the presentation of the CPI and other price data.
In fusing these, we arrive at a single conclusion: Profit margin squeeze!
Figure 3
First, authorities say that while the Food and Beverage CPI has spiked since February this year, the Restaurant and Accommodation CPI has stagnated. The share of restaurant CPI is 9.47% of the CPI basket, while accommodation CPI represents .15%.
Deduced from the data, unable to pass through prices to consumers, restaurants have been absorbing rising input costs leading to fantastic margin squeezes! (Figure 3, topmost pane)
By extension, it suggests impending closures due to massive losses of marginal players in the industry.
Have we been seeing this?
Or are authorities attempting to downshift the CPI by understating the Resto CPI?
Of course, the Resto CPI is as ridiculous as the Headline. It suggests a "weighted average" consumer spending in the high-end restaurants as with the 'carinderias!'
Authorities also tell us that the price surges are not limited to the consumers but also manifested in factory prices. (Figure 3, second to the highest pane)
The Producers Price Index for April soared to 6.1%, the highest rate since at least 2019! The 2018 base year represents the indexation of the PPI.
Because the rate of change of the PPI has been higher than the CPI, it suggests the same reasons as the Food-Resto CPI asymmetry.
An incredible margin squeeze of the intermediaries: The inability of outlets catering to consumers to transmit higher input prices through increased selling prices.
There is more.
The General Wholesale prices, which measure changes in price level flows into the wholesale trade intermediaries, corroborate this perspective. The price change of the Wholesale sector rocketed to 8.3% in April! (Figure 3, second to the lowest pane)
As a result, the spread between the CPI and wholesale prices has been negative since November 2021!
If accurate, one can imagine the extent of losses endured by the wholesale intermediaries!
Self-evidently, a sustained financial hemorrhage of this sector should lead to the eventual closures of many affected marginal firms!
V. Widespread Diffusion of Price Pressures: Factories Race to Hoard and Produce!
Again, from the various price measures (PPI, Wholesale, Retail, CPI), the surging prices represent a widespread phenomenon. (Figure 3, lowest pane)
Reduced demand to hold money has prompted factories to hoard raw materials and produce goods instead.
S&P Markit, June 1: Production volumes and intakes of new orders grew at solid rates. Despite rates of expansion softening slightly from April, they were the second-fastest since November 2018, respectively. In contrast, foreign demand for Filipino goods contracted for the third month running. The downturn was solid and quickened from the preceding survey period. Anecdotal evidence highlighted that ongoing pandemic related restrictions in China led to dampened demand and shipment delays. The ongoing COVID-19 recovery and the relaxation of the pandemic restrictions in the Philippines resulted in improved domestic demand conditions, according to panellists. Thus, manufacturing firms increased their purchasing of preproduction inputs at a sharp rate. Additionally, panellists remained keen to build stocks as they anticipated higher sales in the coming months. As a results, holdings of raw materials and semi-finished items rose for the ninth month running. At the same time, post-production inventories grew at the strongest rate since December 2016. Manufacturing backlogs of work in the Philippines continued to be depleted during May. The fall in work-in-hand was strong overall, as firms highlighted sufficient capacity to process incoming new sales. Demand recovery and greater production requirements resulted in a rise in payroll numbers in May. Workforce numbers increased for the first time since February 2020, and at a moderate pace. Job creation in May follows unchanged staffing numbers seen in April. At the same time, while rates of inflation slowed, both average cost burdens and output charges rose markedly during May. Exacerbating increases in expenses, May data also signalled a further deterioration in vendor performance, as lead times lengthened to a greater extent than in April. (bold added)
The survey tries to rationalize a pickup in domestic demand as a reason for production increases while downplaying the foreign demand weakness.
Yet this reasoning represents a square peg in a round hole.
Bogged down by vendor performance, producers are stocking "preproduction inputs at a sharp rate," which led to increased holdings of raw materials and semi-finished goods.
Yet, producers are suffering from marked increases in the average cost burdens while attempting a pass-through to the consumers through higher output charges.
To be sure, increasing inventories amidst price surges by producers looks like a reflexive response to the ongoing disruptions in the supply chains.
So while companies are trying to preserve margins by producing now, prompted by the current disruptive conditions, increased output charges must have led to the "strongest rate" of post-production inventories.
Put bluntly, insufficient demand for producer goods must be the reason for the rapid buildup of inventories!
And while it may be good news to see employment pickup for the first time since February 2020, a month may not represent a trend!
In the end, if the anticipated demand does not surface in the future, not only will excess inventories pose a burden to producers but also prompt them to cut jobs!
Figure 4
The PSA data on factory conditions also illustrates the money illusion.
Since January 2022, net sales in value have massively outsprinted volume.
Net sales value spiked by 20.13% YoY in April, while volume expanded only by 13.26%. Value has outsprinted volume by 6.9%, perhaps the widest in several years. (Figure 4, upmost pane)
Since January 2022, the net increase in sales value over volume has only accelerated.
This dynamic represents the law of demand or, "as the price of a good increases, the quantity demanded decreases," in action!
In the case above, as the growth of sales value surges, the sales volume growth slows.
The irony is that the PSA barely sees a boom in factory conditions. The production value and volume remain below 2018 levels. (Figure 4, middle pane)
The conspicuous boom is in bank credit to the manufacturing sector, which soared by 12.35% in April, a rate last seen in early 2019. (Figure 4, lowest pane)
Aside from operations, aggressive bank credit expansion must have bankrolled the massive stockpiling of raw material and semi-finished goods.
The bank-financed race to hoard explains part of the surge in prices of preproduction inputs, aside from higher energy prices.
Stagflation Ahoy!
VI. Mounting Policy Risks from the BSP’s Seriously "Behind the Curve" Policies!
Interestingly, while authorities granted jeepney drivers a temporary Php 1 hike in transport fares, some jeepney operators and drivers have decided to either cut short or halt their trips altogether.
If this becomes rampant, then the commuting public may be severely affected. Echoing the response to policy response to Covid-19, immobilization may hamper the division of labor.
But there’s more.
The election promise by the incoming administration of a Php 20-kilo rice is intriguing.
Despite the noises about the proposed mechanism, a massive and rigorous price control appears to be the only way for this to materialize. A compliment would be to provide substantial subsidies to rice farmers.
In this case, the CPI may plunge, but the availability of rice will move to the black markets. Or, rice may be cheap but may be unavailable to the public.
After all, shortages are the natural consequence of price ceilings.
Also, subsidies translate to intensifying debt finance deficit as public spending accelerates.
At any rate, the above developments justify the selloff in the treasury markets, which likely won't be going away anytime.
Figure 5
Despite the BSP's baby step 25 bps hike, the spread between the official rates and 10-year Treasury yield continues to widen, which indicates that the present monetary policy of the BSP remains seriously "behind the curve," reflecting escalating risks of policy error. (Figure 5, highest pane)
It suggests that the BSP may panic, similar to 2018, and raise rates significantly in haste.
But from our perspective, since the BSP engaged in zero-bound policies, it has fostered and nurtured malinvestments, representing a massive policy error. An artificial boom ends with a bust.
At the same time, while the BSP announced the partial pullback in its QE, the backend of the treasury markets has been reflecting liquidity strains.
For instance, while the 20-5 year differential has recently bounced, the general trend exhibits a bearish flattening indicating a sharp slowdown in economic activities over time. (Figure 5, second to the highest window)
VII. CPI Response: Financial Liquidation, PSEi 30 Endured a 3.14% Weekly Plunge! Higher Rates a Bane to the Property Sector
And higher inflation expectations, rising rates, and emerging liquidity strains explain why financial asset selloffs percolated into the stock market!
After repeated attempts at orchestrated pumpings, the 3.38% selloff last Friday pulled the benchmark PSEi 30 lower by 3.14% over the week.
Figure 6
The holding (-4.4%) and services (-4.21%) sectors bore the brunt of selling from foreign money. Foreign funds sold Php 2.56 billion this week. (Figure 5, second to the lowest and lowest windows)
Interestingly, having built some cushion before Friday’s meltdown, the property sector (-1.8%) took a lighter blow. As a result, its share of the PSEi 30 basket bounced. (Figure 6, highest window)
Aside from the banks, interest rate risks loom large in the property sector, which depends on substantial leverage for its operations.
The share of bank loans to the real estate sector recently hit a record high. (Figure 6, middle pane)
To ensure its liquidity, the BSP extended the loan cap of banks to the property sector to 25% in August 2020, effectively implementing a bailout for both sectors!
If inflation is the problem, surging rates will eventually weigh on the property sector.
From a technical perspective, a rounding top continues to hound the benchmark, with the latest trendline vulnerable to further violations. (Figure 6, lowest window)
The slack in volume amplifies such susceptibility.
It should be interesting to observe how the overpriced and overleveraged PSEi 30 navigates the treacherous waters of stagflation for its survival.
Yours in liberty,
The Prudent Investor Newsletters
