A loose Fed monetary policy (i.e., a positive sloping curve), sets in motion a false economic boom — it gives rise to various false activities. A tighter monetary policy, which manifests through an inversion of the yield curve, sets in motion the process of the liquidation of false activities (i.e., an economic bust ensues).—Austrian Economist, Frank Shostak
In
this issue:
Red
Alert: Philippine Bonds Warns of Rapid and Dramatic Deterioration of
Domestic Liquidity Conditions!
-Yields
of T-Bills Soars!
-Yield
Spreads: From Flattening to Inversion!
-Yield
Inversion: Symptoms of Balance Sheet Problems
-The
Implications of Negative Spreads
-Phisix
6,900: Desperation Calls For The Rampant Use of Marking the Close
Pumps!
Red
Alert: Philippine Bonds Warns of Rapid and Dramatic Deterioration of
Domestic Liquidity Conditions!
I
am supposed to be on a holiday break, but recent developments at the
Philippine bond markets have been too compelling to ignore because
they have been signaling significant turn of events.
A
week ago, I
wrote about the intensifying signs of the flattening/inverting of
the domestic yield curve as one of the factors that should not only
inhibit any meaningful return of risk appetite, but likewise amplify
the risk of an economic recession, as well as, risk of a credit
crunch.
Apparently,
this week’s market activities only reinforced my suspicions.
Yields
of T-Bills Soars!
The
above represents nominal BPS week on week changes
As
of last week, yields of 3 and 6 months bills have rocketed! 5 year
yield also jumped!
Perhaps
most of the bond yield manipulators went on a Christmas vacation too
soon for the surge in yields to have been unleashed.
Nevertheless,
to repeat this has NOT been a HOLIDAY dynamic.
The
following charts of the yields of 1, 3, and 6 month should tell us
why.
Whether
seen on a weekly (left) or monthly (right) basis yields of ALL three
short term bills (again 1,
3
and 6
months) have spiked to MILESTONE HIGHS!!!
To
put milestone in perspective, the weekly rates have been HIGHEST
since 2014, while the monthly rates have likewise been HIGHEST
since 2012!
However,
investing.com charts have been limited to these time frame
perspectives. And I suspect that the current yield have reached
levels MORE than the demonstrated years.
And
with the longer end little changed, the result has been a drastic and
a dramatic curve flattening!
What
you see depends on where you stand. So let us widen the angle to see
how bond yields performed on a year to date basis.
Again
the same dynamic holds: The yields of the short to mid end curve have
been ascending FASTER
than long term counterparts.
And
that’s the reason why we have seeing the flattening to inversion
process.
Now
such dynamic now applies to almost the entire domestic bond spectrum!
Yield
Spreads: From Flattening to Inversion!
Nevertheless,
considering that the 10 year bond yield has been used as the
mainstream’s benchmark, I will use them here to compare with the
bills and notes counterparts.
I
have
noted during the mid-week that the coupon yield of the 1 month
bill soared to a shocking 3.96%, but the yield has partly backed off
from its high last Friday.
Now
the above charts shows the spread between soaring yields of T-bills
and 10 year bond equivalent.
The
10yr-1 month spread has narrowed to just 66 bps! (upper window)
The
10yr 3 month spread has dived to just 140 bps! (middle window)
And
worst, the 10yr 6 month has collapsed to an astoundingly paltry 18
bps differentials! (lower window)
In
short, the front end of the curve appears to be fast approaching an
inversion!
Again
the above charts reveal that this has NOT been anomaly but an extant
dynamic for at least one year. It’s just that recent developments
have been accelerating or escalating!
Let
us move on to the spreads of the 10 yr relative to longer 1 and 2
year notes.
Apparently
both have been plagued by the same flattening conditions as with
T-Bill contemporaries.
It’s
true that the above spreads have somewhat or marginally widened from
previous levels last week, but they remain at landmark lows (as shown
by the red arrows)!
Moreover,
like the front face, the spreads above have been flattening from last
year, but has only intensified during the last quarter.
Understand
that the 10yr – 2yr benchmark has been a favorite bellwether by
mainstream institutions like ADB. So perhaps current improvement on
the 10yr-2yr maybe due to interventions to facelift the curve’s
conditions.
However
whatever cosmetic changes being applied by manipulators, it appears
that they haven’t been successful in the concealment of the
inversion process.
As
I have earlier pointed out, it’s not just flattening anymore,
negative spreads have already appeared.
For
the FOURTH STRAIGHT week, the 10 yr-3 yr yield spread remains
NEGATIVE!!!!!!!!!!!!
…and
apparently, negative spreads have not been confined to 10 yr and 3yr
anymore, they have now been joined by….
…the
10yr-5yr where the curve’s spread just crashed to negative last
week!
This
is totally stunning!
Yield
Inversion: Symptoms of Balance Sheet Problems
The
crux is: The abrupt narrowing of spreads has now spread to envelop
the entire Philippine treasury curve.
The
question is WHY has this been happening?
The
obvious main answer is that there is no such thing as a free lunch
forever.
Balance
sheet growth has inherent limits. The
continuing massive bank credit inflation has caused short term rates
to rise relative to the longer end.
Despite
headline profits, many
highly levered firms have HARDLY been generating sufficient cash
flows to pay for existing liabilities.
Many firms have been using NEW debt to pay for EXISTING debt. And
these have partly been ventilated through heightened
demand for short term loans. Importantly, these firms have been
competing
intensely
with each other for access to these scarce funds.
Meanwhile,
as part of exercise to meet current funding requirements, holders of
existing short to mid end papers have also been frantically selling
these securities to spur the upsurge in yields!
This
is simply a symptom of the unraveling of malinvestments.
Remember,
that only a few entities in the population have access to the formal
credit (banking/bonds) system. Hence, the zero
bound to negative spreads are symptomatic of increasing
concentration of credit risks!
And
such inversion dynamic appear to be signaling the intensification of
financial stress within the system.
Now
the mainstream would like to blame the US Federal Reserve for current
developments. Yet the above charts exhibit that the FED may only be
an aggravating factor and not its main cause.
The
Implications of Negative Spreads
And
think again of what the evolving spreads will do to bank lending
activities. Or what will happen to the banking system’s maturity
transformation (borrow short, lend long)?
The
compression of Net Interest Margins will force banks to sharply
reduce credit activities. And loans
represent about half of banking assets.
And
with the BSP’s
2009 pivot to spur domestic demand through “expansionary monetary
policy”
in order to embellish statistical GDP, this entailed the entrenched
dependence on credit.
As
of 3Q, for every Php 3 of loans
issued by the banking system (BSP current production loans) such
has only generated Php 1 of government’s inflated NGDP (GDP at
current price)!
Given
that I believe that NGDP has been INFLATED, then the credit/NGDP
ratio or credit intensity must be HIGHER!
And
any material reduction in credit activities will NOT only diminish
statistical GDP, it would raise credit risk
as well! Remember, credit money accounts for about 70% of domestic
liquidity (76%
M3 October 2015), hence a fall in credit activities will
translate to a drop liquidity (money in circulation) which should
distill into GDP (NGDP and Constant ‘real’ GDP)!
Think
of what happens to asset markets too. If the so-called ‘fundamentals’
of asset markets have been juiced up by credit, then the reduction of
credit activities will deduce to its deterioration.
And
if asset market pricing (boom) has similarly been pillared by credit,
then diminished credit activities would substantially lessen
demand for risk assets!
Said
differently, a
reduction of credit activities will lead to a substantial repricing
of the considerably overpriced and mispriced assets.
Hence,
overpriced and mispriced assets maybe vulnerable to violent
adjustments (a.k.a crashes)
2015’s
surge in yields should also translate to financial losses for
institutions who bought these debt papers during its heydays.
However, accounting classification may have shielded them from
revealing their actual status. The
recent DBP ‘market manipulation’ controversy provides clues to
such dynamics.
Now
if half of the banking balance sheets have constituted loans and
other the half have been divided into financial (and property)
assets, and fees, then both will similarly be vulnerable to a
downturn in economic activities and from a hefty repricing of assets.
To
make a long story short, this
means there will be a transmission and feedback mechanism through the
sequence of slowing credit growth to NGDP to earnings to asset
pricing to credit risk and vice versa.
Developments
in the Philippine credit market have been in sharp contradiction to
what the mainstream has been projecting. For instance Fitch
ratings has recently sold the chestnut that Philippine banks appear
to be in tiptop conditions. Fitch appears to be reading
statistical leaves while overlooking market signals.
For
most of the mainstream, statistics or historical numbers only
matters. Crucial market signals, especially one that affects the core
of the present GDP G-R-O-W-T-H template, much like basic economics,
exists
in a vacuum or a black hole.
Furthermore,
if yield compression will force banks to substitute volume for
margins, then obviously this will come at the expense credit quality,
thereby amplifying credit risks.
As
I recently
wrote: So the
banking system must be so desperate as to seek margins by gambling
away depositor and equity holder’s resources through the
assimilation of more credit risks by lending to entities with poor or
subprime credit ratings.
Of
course, higher
yields don’t just imply credit risk, they also expose many sectors
to interest rate risk!
Weak
Peso Compounds on Liquidity Squeeze, the 3Q Foreign Investments as
G-R-O-W-T-H Mirage
And
to compound on the tightening liquidity noose has been the sustained
weakening of the peso.
Not
only will an infirm peso increase prices of imported items, it will
reduce demand for peso assets, and more significantly, it will
magnify the onus from foreign denominated liabilities. That’s
because a weak peso means more pesos to service every US dollar debt
owned.
The
flagging peso continues to draw foreign money away from domestic
financial markets. Foreign money exodus also contributes to a wobbly
peso. It’s a feedback loop. Foreign portfolio according
to the BSP posted net outflows last November.
Forgive
me, but I would question government’s relentless efforts to
exorcise the deterioration in real economic activities through the
repeated shouting of statistical talismans.
By
real economic activities I don’t mean constant ‘deflator
adjusted’ prices. Recall that constant ‘deflator adjusted’
prices magically
transformed negative into positive performances in 3Q
GDP.
Instead,
I allude to a living and breathing, and not an artificially
constructed puffed up numerical economy.
While
it may be true that government statistics which show foreign
investments up 165% in Q3, one quarter does not a trend make.
Moreover,
foreign investments numbers tend to be extremely volatile. Having
said so, they don’t imply G-R-O-W-T-H!
History
shows us why. From 2010 through 2015, two out of six years posted
negative 3Q growth, specifically in 2012 -35.14% and in 2014 -44.32%.
(green circles). So from a statistical perspective 3Q 2015 data shows
of a base effect: current numbers reflect a reversal from the troughs
of 2014.
Also
this implies of little correlation or even causation with GDP.
Foreign investments cratered even when GDP
climaxed in 2012!
Additionally,
correlation between foreign investments and the peso (BSP’s
monthly average end of 3Q) have been loose so far. (top window)
This again suggests that the low USD-php volatility in the recent
past has had little influence on foreign investments. Such
relationship may be altered when currency volatility crescendos.
Worst,
historically, huge nominal
gains have coincided with collapses, as seen in 1997 and 2008!
(orange ovals)
And
the same phenomenon applies even on significant gains in terms of %
growth, as seen 1997, 2001 and 2005 (peaks in blue trend line).
Besides,
foreign investments are not like foreign portfolio flows, where the
latter tends to reflect on real
time
market activities.
Foreign
investments have to be “approved” by respective government
authorities or regulators. This means foreign investments have to
undergo the political bureaucratic screening process by specific
agencies based on technical legal guidelines as prescribed by the
national government. So it would be obvious that such statistical
numbers and or the release thereof would involve certain political
elements or contain some degree of political influence. And given the
embedded nature of politics on foreign investments, what stops the
government from either ‘timing’ its release or embellishing such
numbers? Given that government operates as monopoly, who will be
there to verify on the authenticity of those numbers? Yet we are
supposed trust those numbers.
Nonetheless
there has been little evidence where
the government’s recent liberalization contributed to the spike
in 3Q foreign investments. That’s because except for agriculture
and energy, it’s mostly the
bubble sectors which benefited from the recent surge in foreign
investments.
Besides,
given the amplification of the risks of a global recession, this will
not only affect foreign investments but likewise magnify risks of
protectionism. Because inflationism represents an implied
protectionist policy, it is INCOMPATIBLE with liberalization. And the
consequence of inflationism will unfortunately (to my dismay as
libertarian) lead to protectionist
impulses or more politicization of the marketplace, the APEC
boondoggle notwithstanding. The domestic strongman
rule bubble already serves as manifestation of the rise of
populist protectionist politics.
At
the end of the day, with monetary conditions rapidly and severely
tightening, unless such juncture radically improves, then 2016 should
be a mainstream SHOCKER!
As
final thought, if
the shrinkage of domestic liquidity will lead to deflationary
pressures, particularly in parts of the economy where areas or
industries have been afflicted by excess supply and debt overhang, on
the other hand, the weak peso will lead to inflationary pressures on
areas dependent on imports. So the Philippines will likely see a
coming stagflationary environment—a simulacrum of the post 1997
era.
Phisix
6,900: Desperation Calls For The Rampant Use of Marking the Close
Pumps!
The
Phisix stormed to a 1.96% gain over the week on a very low volume
rip.
As
for the volume, at an average of Php 5.55 billion, daily volume
signified the FOURTH lowest for the year! So essentially sellers took
advantage of aggressive bids to unload on high prices.
But
what has really been striking has been the rampant “marking the
close” sessions used to attain the week’s gains.
On
Monday, the Phisix losses hit a peak of 1.8%, approached the runoff
period down .64% but shockingly closed up by .16% from a spectacular
two issue pump! Marking the close produced a whopping .81% swing to
turn negative into positive!
And
58.2% of SMPH’s eye-popping 8.25% jump to a new record high came
from a last minute pump. And so with GTCAP, where 82% of the day’s
6.02% gains came from marking the close.
Since
SMPH ended the week at Php 21.8/share or down Php 1.15 from the
record Php 2.95, it’s really sad to see how price fixing actions by
some entities have led to undue losses on resources used for such
desperation headline enhancing pumps.
The
same applies to GTCAP which closed at Php 1,262, though up 3.19% for
the week, had been down Php 37 or 2.8% from the Php 1,299 pump.
I
posted the egregious price
fixing session here.
This
wasn’t limited to Monday.
Friday’s
session saw the Phisix down by 1.09% prior to the runoff (see upper
window). All of a sudden, the Phisix closed down by only .56%! This
shows how 49% of the day’s losses had been wiped out from Friday’s
price fixing session! A four issue pump had been used to bolster the
index.
Hasn’t
it been an oxymoron to think the Philippines
have supposedly reached “developed economy” status yet
depends on brazen price fixing or cheating its way to attain such
ends?
Last
week’s rally was more than just about low volume, it was also about
divergence:
Among
the 30 composite issues constituting the PSEi index, 23 issues posted
advances, 6 posted losses while 1 was unchanged.
In
contrast, the broad market was tilted heavily in favor of sellers
(lower right window). Declining issues topped advancing issues by 99.
Declining issues led in 3 out of the 5 trading days of the week.
Such
divergence reveals of the cosmetic actions to festoon the headlines.
It’s
really a spectacle to see how price fixers have been frantically
attempting to prop the index up in the face of shrinking liquidity.
It’s an example of picking up coins (pennies) in front of
steamroller founded on hopium.
And
sad to say hopium has never been a good strategy.
/cdn0.vox-cdn.com/uploads/chorus_asset/file/3742634/lightsabers_rev.0.png)
