Every inflation must eventually be ended by government or it must "self‑destruct"—but not until after it has done untold harm—Henry Hazlitt
In this short issue
Why the BSP will be Slashing its Policy Interest Rates Soon
I. Led by T-Bills, Yields of Treasury Curve Crashed: "Bullish Steepener"
II. BVAL Treasure Rates Below the BSP’s Policy Rates; The Erosion of Inflation Tax
III. BSP’s Asymmetric Monetary Policies
IV. BSP’s Possible Rationalizations: Expected US Fed Rate Cuts and Escalating Streak of Global Central Bank Easing
V. BSP’s Zero Bound Policies and the PSEi 30’s Diminishing Returns
Why the BSP will be Slashing its Policy Interest Rates Soon
The recent crash in the yields of the Philippine treasury curve has strongly signaled the BSP’s coming rate cuts.
I. Led by T-Bills, Yields of Treasury Curve Crashed: "Bullish Steepener"
Will the streak of BSP rate cuts start this December or early 2024? Why? Because these have been communicated to the public by the local treasury market.
Figure 1
The reliable but unheralded treasury traders—via demonstrated preference (action speaks louder than words)—have been on a Treasury panic buying spree that sent yields collapsing across the curve. (Figure 1, upper window)
Treasury traders appear to be expecting a (possibly a "surprise") sharp decline in inflation. If so, a disinflationary environment entails a weaker private sector economic performance this Q4.
Since its peak last November 16th, the recent tailspin of the 1-month T-bill yield hallmarked the performance of various Treasury maturities across the curve.
Yet, the scale of the decline (1- and 3-month T-bills) has been substantially deeper compared to the Q2 2019 episode when the BSP began its credit easing campaign. (Figure 1, lower graph)
And this may be pressing enough to force the BSP to act.
Figure 2
Furthermore, since yields of short-term or T-bills have plunged the most, this reshaped the slope into a "Bullish Steepener"—frequently pointing to rate cuts.
Treasury curve abruptly steepened from a relatively "flat" slope last September and October. (Figure 2, upper chart)
II. BVAL Treasure Rates Below the BSP’s Policy Rates; The Erosion of Inflation Tax
What’s more, the across-the-curve plunge in treasury yields has resulted in a sharp tightening—BSP overnight interbank rates have become HIGHER than treasuries! (Figure 2, lower graph)
Figure 3
On top of this, BSP rates have been higher than the CPI and the headline GDP, reinforcing this financial "tightening" phase on an economy heavily dependent on leverage and liquidity.
Crucially, higher BSP rates than the CPI—theoretically—translate to positive "real" rates, which implies that this has eroded the government's seignorage fee or the inflation tax.
The BSP embarked on rate cuts when "real" rates turned positive in Q2 2019. (Figure 3, upper graph)
III. BSP’s Asymmetric Monetary Policies
But, of course, monetary authorities have recently engaged in asymmetric policies.
Sure enough, it has raised headline rates to multi-decade highs, which reduced credit transaction growth mainly to the supply side.
But its interest rate cap on credit cards or subsidies to consumer credit has also resulted in a textbook response of fueling excess demand for consumer credit. (Figure 3, lower chart)
Such extensive build-up of leverage in the consumer's balance sheets has driven the indulgent demand for vehicles, luxury-related spending activities, and magnified property speculations.
The other ramification is the transformation of bank lending operations towards consumers at the expense of industry.
Other behind-the-scene operations have marked the BSP's liquidity operations.
Banks and non-bank financials have been directly financing the National Government’s deficit spending via Net claims on the Central Government (NCoCG) or indirect QE—injecting liquidity into the government and the financial system.
These off-kilter operations afforded the BSP to raise headline rates and paint an impression of a "sound" macro-environment.
IV. BSP’s Possible Rationalizations: Expected US Fed Rate Cuts and Escalating Streak of Global Central Bank Easing
Figure 4
Aside from inflation, the BSP could rationalize its actions with the widely expected rate cuts by the US Federal Reserve in early 2024 and use the appeal to the majority—the growing streak of rate cuts by global central banks. (Figure 4, upper chart)
Figure 5
Previously, changes in the BSP policy rates have coincided with the gyrations in the yield differentials of the Philippines and the US (proxied by the 10-year). BSP rate cuts in 2019 narrowed the spread between the 10-year Philippines and the US. (Figure 4, lower diagram)
Today, since the US Fed has adopted a more hawkish stance than the dithering BSP, this broke the previous correlations—the rate spread has compressed even as the BSP held on its rates at multi-decade highs.
Put this way, domestic developments determine the BSP policies.
Of course, since current developments in the treasury markets have anchored our anticipation of the possible changes in the BSP's policy stance, this is also conditional on the sustainment of this unfolding trend.
V. BSP’s Zero Bound Policies and the PSEi 30’s Diminishing Returns
Finally, the establishment experts have been whetting the speculative impulses of the disenchanted public starved of easy money gains with the prospects of a stock market boom from "rate cuts."
True, "rate cuts" have had ephemeral amplifying effects on the YoY returns from 2009-2018, but this relationship broke in 2019 (pre-pandemic). (Figure 5, top chart)
But "rate cuts" had to be bolstered with the BSP's historic Php 2 trillion liquidity injections to spur a momentary rally in 2H 2020 to 1H 2021.
Worst, the BSP’s zero bound (ZIRP) policies have been associated with the PSEi 30’s diminishing monthly long-term returns.
It is no coincidence that the rate cuts have fueled spikes in the CPI and contributed to the attenuation of the Philippine peso, which are all interrelated with the PSEi 30’s return. (Figure 5, lower graph)
Artificial speculative booms from free-lunch monetary policies only induce capital consumption and a lower standard of living.
