So, why haven’t financial conditions tightened? How have markets been able to counter Fed tightening measures? Because the system has avoided de-risking/deleveraging. Leveraged speculation, the marginal source of marketplace and system liquidity, has been undeterred by Fed rate hikes. Risk embracement has persisted, holding risk aversion and associated tightening at bay—Doug Noland
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In this issue
In Defiance of the Philippine Treasury Markets, the BSP Kept its Policy Stance; Bank Consumer NPLs Rebounds in Q3; From the "Powell Pivot" to the "BSP Pivot"
I. Two Reasons Why the BSP Defied the Treasury Markets
II. BSP: "Inflation Leans Significantly to the Upside," Treasury Markets See Disinflation
III. Evidence: Inflation Leans Significantly to the Downside
IV. Asymmetric Policies Redux: BSP Defiance Anchored on Subtle Liquidity Operations: Bank QE and Household Credit
V. Critical Areas of the Economy Exhibiting Substantial Slowdown
VI. The "Too Big to Fail" Banking System
VII. Consumer Strains Emerge: Credit Card, Salary Loans, Motor Vehicle, and Real Estate Loans Rebounds in Q3!
VIII. The "Powell Pivot" as a Ground for the "BSP Pivot"
In Defiance of the Philippine Treasury Markets, the BSP Kept its Policy Stance; Bank Consumer NPLs Rebounds in Q3; From the "Powell Pivot" to the "BSP Pivot"
The BSP kept its policy rates unchanged and remained at odds with the Philippine Treasury markets even as signs of economic slowdown and disinflation spread.
I. Two Reasons Why the BSP Defied the Treasury Markets
Defying the markets, the BSP held on to its policy rates last week.
Here are their two reasons:
BSP, December 14, 2023: The BSP The balance of risks to the inflation outlook still leans significantly toward the upside. Key upside risks are associated with potential pressures emanating from higher transport charges, increased electricity rates, and higher oil prices. Meanwhile, the impact of a relatively weak global recovery as well as government measures to mitigate the effects of El Niño weather conditions could reduce the central forecast. At the same time, the country's medium-term growth prospects remain firm, with strong demand expected in the fourth quarter due to sustained consumer spending and improved labor market conditions. The BSP will also continue to monitor how firms and households are responding to tighter monetary policy conditions alongside evolving domestic and external economic conditions. (bold mine)
Two propositions justifying the BSP's position: supply side and strong economy.
First, the BSP remains adamant about inflation representing a supply-side dynamic.
Second, inflation is a natural outcome of strong demand, hence, the economy.
Huh?
So, supply-side disruptions have spurred extraordinary strength in demand? By their logic, authorities should continue to throw barriers to the supply side to "boost demand," which should translate to "economic growth!"
See the conflicting claims from such gibberish?
Then, the BSP added that they would monitor the household's (and firms') response to the tight monetary policy. (How about San Miguel’s 1.4 trillion debt?)
If demand is a consequence of productivity growth, why bother?
The opacity from their drivel represents an attempt to conceal the mounting fragility of household's (and the economy's) balance sheet conditions in response to the BSP's policies.
Nonetheless, let us examine some of their claims.
II. BSP: "Inflation Leans Significantly to the Upside," Treasury Markets See Disinflation
The BSP claimed: "Inflation leans significantly to the upside."
Figure 1
The Treasury markets firmly disagree. They see disinflation instead.
This week, while T-Bills yields rallied to regress to the pre-CPI level, they have hardly reversed a substantial portion of the deficit from the recent dive. (Figure 1, topmost chart)
Besides, T-bills have been overbought, so the rebound signified a reflexive response.
What's more, with the drop in yields of notes and bonds, the Philippine Treasury curve flattened anew to indicate more tightening. (Figure 1, middle graph)
Remember, the BSP (and the consensus) NEVER saw the inflation shock/crisis and had been compelled to respond forcefully.
In contrast, the treasury markets had consistently been ahead of the BSP. (Figure 1, lowest window)
Here is the thing. Should falling T-Bill rates persist, the BSP will not only "pivot" with incremental cuts. Instead, they're bound to chase the markets with panic cuts.
Our bet is with the Treasury traders.
III. Evidence: Inflation Leans Significantly to the Downside
The government's data also exhibits the unfolding widespread and predominant disinflation process.
Figure 2
The PSA's general wholesale and retail price indices have resonated with the CPI’s downdraft. (Figure 2, topmost graph) Consumer boom?
The slowdown in bank manufacturing loans resonates with the downdrift in the Producers Price Index (PPI). (Figure 2, middle pane) Manufacturing boom?
Despite the bounce in universal commercial bank loans to the industry last October, the PSA's Construction Materials retail and wholesale prices have also been southbound. (Figure 2, lowest chart) Real estate and construction boom?
IV. Asymmetric Policies Redux: BSP Defiance Anchored on Subtle Liquidity Operations: Bank QE and Household Credit
Figure 3
But there have been signs of improvement in liquidity conditions. Despite the BSP rates at multi-year highs, exploding household credit growth has contributed to the expansion in money supply represented by cash and M3. (Figure 3, topmost chart)
That's aside from the unprecedented injections by banks to the government through the Net Claims on Central Government (NCoG), which was up 19% YoY in October. (Figure 3, middle window)
Ironically, despite the assertion that the BSP is tightening, industry or supply-side credit improved in October (7.6%), which led to an increase in universal commercial bank’s aggregate credit (5.9%). (Figure 3, lowest graph)
Once again, this exhibits the asymmetric policies embraced by the BSP.
Though headline CPI has cooled, credit expansion and liquidity support remain robust in subtle and less noticeable areas of the economy, which explains the BSP resistance.
The thing is, should the money supply growth rate accelerate past double digits for a considerable time, expect a turnaround in the CPI (with a time lag).
V. Critical Areas of the Economy Exhibiting Substantial Slowdown
Several crucial segments of the economy have shown signs of emerging weakness.
Figure 4
Though media have cited the contraction in exports, imports, and total trade last October, the more notable segment has been the plunge in Semiconductor exports and the sustained deficit in capital goods imports.
Weakening microchip exports, which accounted for 44% of the total, could signal the deterioration in the global economy. (Figure 4, topmost diagram)
And while consumer goods imports have risen 4.8% YoY, its nominal USD data appear to be plateauing—portentous of reduced consumer demand. (Figure 4, middle graph)
In the meantime, the weak capital goods import dovetails with the FDI (see below).
Manufacturing data exhibited significant softening in October, with value and volume growth plummeting from 8.9% and 9.1% in September to 1.3% and 1.7% in October—a possible confirmation of the PPI.
Tourism (DOT) data have also exhibited symptoms of "peaking," where nominal foreign arrivals showed sparse improvement last November. But because of the base effect, YoY changes remain amplified. (Figure 4, lowest chart)
Reduced foreign arrival or inflows mean that the rapidly expanding accommodation and food services would increasingly depend on demand from local tourists—whose recent spending spree has been financed by credit.
October's employment data, supposedly on multi-year highs, masked the surge of the non-labor force and underemployment segments, which were far bigger than the growth of the employed, discussed here.
Figure 5
Despite promises of foreign investments from the leadership's numerous foreign travels (junkets), the BSP's FDI data remains sullen, with substantially lower inflows last September and in 9 months. Depending on how one looks at the chart, FDI flows have been in a downtrend since the 2021 spike or from 2016. (Figure 5, topmost chart)
How would there be growth without investments?
There you have it, the unfolding disinflationary process supported by several signs of frazzling economic conditions betokens a substantial slowdown in the Q4 NOMINAL GDP. The headline GDP will now depend on how fast the deflator (implicit index) falls.
In the same plane, the revenue growth of listed companies could exhibit more slackening from signs of demand attenuation.
The BSP's facade only increases the chances of a sharp deterioration of the economy or the financial sphere that could compel them to reverse their position rapidly.
At any rate, regardless of the BSP's official stance, that’s a when and not an if.
VI. The "Too Big to Fail" Banking System
Another BSP concern: "...monitor how firms and households are responding to tighter monetary policy."
Why these?
The banking system has been undergoing a dramatic transformation in its business model.
First, they've focused on consumers rather than the supply side.
Second, banks have become primary financiers of the government's deficit historic spending via NCoCG.
Last, entwined with the second, banks have also committed more resources to investment assets, hence the record Held to Maturity assets (HTM).
We were supposed to discuss this on a bank-focused post, but the lack of time pushed us to defer.
In any case, we shall focus on the FIRST model.
The share of universal commercial bank lending to consumers (ex-real estate) has risen to an All-Time high last October! All. Time. High. (Figure 5, middle diagram)
More critically, the banking system has become the primary liquidity provider of the financial system. Banks have been monopolizing the nation's Total Financial Resources! They now control 82.8%! All. Time. High. (Figure 5, lowest graph)
The BSP's EZ money regime has benefited banks at the expense of non-bank financials and the capital markets.
Banks have also become "TOO BIG TO FAIL," which explains the Php 2.2 trillion liquidity injections in 2020-21.
VII. Consumer Strains Emerge: Credit Card, Salary Loans, Motor Vehicle, and Real Estate Loans Rebounds in Q3!
Last September, I warned about the coming deterioration of the consumer balance sheet.
Consumers have filled the gap of their income's loss of purchasing power through increased balance sheet leveraging. Of course, this increase in demand powered by credit unfilled by supply leads to "too much money chasing too few goods" or inflation!
And so, the vicious feedback loop of borrowing to address higher prices, which results in higher prices, and vice versa.
…
The bank's gamble with consumer spending may be about to backfire.
As of Q2 2023, though the growth of non-performing loans (NPL) salary loans has stalled, stagflationary conditions are likely to push it higher. (Figure 1, middle pane)
NPLs of credit cards appear to be bottoming. Likewise, stagflationary conditions are likely to accelerate this ratio. (Figure 1, lowest graph) [Prudent Investor, September 2023]
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Nota bene: the BSP's pandemic relief measures included provisions that allowed banks leeway in various reporting requirements. (C&G Law, May 2020) As such, banks were able to disguise a considerable number of losses. It is not clear whether the BSP has lifted these measures.
Well, here it is.
The data indicated below are the consumer loans and NPLs in pesos (billions). Due to the lack of space, we omit their share of the various benchmarks such as total segment, aggregate loans, etc.
Figure 6
In any event, despite the relief measures, non-performing loans of credit cards, salary, motor vehicles, and consumer real estate have rebounded. The momentum is likely to pick up speed as the economy decelerates. (Figure 6)
So, aside from the real estate sector, consumer and consumer-related loans represent the "Achilles Heel" of the banking system.
Because banks are "Too Big to Fail," once credit and liquidity falter fast, the BSP won't just be panic-cutting rates; they are likely to incorporate the Pandemic bailout template of another monumental multi-trillion peso liquidity injections, combined with increased relief measures coupled with another historic blowoff in deficit spending.
By then, the USD Peso will pierce through the Php 60 level like a (hot) knife through butter!
VIII. The "Powell Pivot" as a Ground for the "BSP Pivot"
Finally, after sustained insistence of "higher for longer," US Fed Chair Jerome Powell's much anticipated "Pivot" sent global capital assets into a stream of speculative frenzy, which, if sustained, could mean a floor on global inflation (with a time lag).
However, after using the US Fed as a pretext for its incumbent stance, we can expect our local monetary officials to use the "Powell Pivot" to rationalize the domestic "BSP Pivot."
From a speech of the newly appointed BSP Chief Eli M Remolona, Jr last August:
We need these reserves because, we think, the world will slow down next year and in the following years, especially [because] of what the Fed has done. As you know, the Fed has tightened so aggressively that it is bound to slow down not just the US economy but also the rest of the world. This poses risks to us and other emerging markets because financial accidents could happen (Remolona, 2023)
Since the markets, via people's time preferences, not the BSP or central banks, are supposed to set rates, determining the "natural rate" signifies an exercise in futility. Excessive policy looseness or tightness would only foster imbalances.
We end this post with a quote from Austrian economist Dr. Frank Shostak on central bank tightening,
Tight interest rate policies restrain economic bubbles, which emerge from low interest rate policies that encourage banks to lend money not backed by savings. Easy money policies divert money from wealth generators toward speculative bubbles, while a tightening of the policy tends to arrest this trend and set an economic bust into motion. The greater the proportion of all economic activities that are bubbles, the larger the bust will be.
Leaving more wealth at the disposal of wealth generators is a good thing, but when the central bank raises interest rates, it tampers with financial markets and falsifies interest rate signals. This in turn raises the likelihood that businesses will misallocate resources, weakening wealth generation and contributing to the severity and length of an economic bust. (Shostak, 2023)
Expect the "Powell Pivot" to shape the "BSP Pivot!" Brace for its repercussions.
___
References
Bangko Sentral ng Pilipinas, Monetary Board Maintains Policy Settings, December 14, 2023, BSP.gov.ph
Prudent Investor, Why is the Philippine Banking System Burning Cash at a Rapid Rate? The Escalating Systemic Risks from Bank Financialization September 17, 2023
Gatmaytan Yap Patacsil & Protacio (C&G Law), BSP Grants Relief Measures to Manage the Financial Impact of COVID-19…Approves Acceptance of Additional Eligible Credit for Rediscounting, et.al, Rajah & Tann Asia May 2020
Eli M Remolona: Rising to the challenge - the Bangko Sentral ng Pilipinas, Bank for the International Settlements, August 14,2023
Dr. Frank Shostak, Why the Fed's Tight Rate Stance Damages the Economy, September 13, 2023, Mises.org
