The irrepressible [John] Law never admitted the flaws in his System. The French ambassador Count de Gergy, who visited Law in Vienna shortly before he [Law] died in 1729, reported that he had ‘never seen a man more stubborn than him about his cursed System, and in such as way that is probable that from the start of its operations he really believed his projects to be infallible’. Central bankers, who resort to printing money, manipulating interest rates and fuelling asset price bubbles, exude a similar air of infallibility—Edward Chancellor
In this issue
BSP’s 15-Year High Policy Rates: How the Philippine Peso, Treasuries and the PSE Reacted; IMF on OECD’s Falling Home Prices Exhibits the Fragility of the Real Estate Sector
I. BSP Hiked Rates to 15-Year High in Just 11 Months!
II. Despite BSP Hike, US Federal Reserve Liquidity Injections Spur a Rally on the Philippine Peso and Regional Currencies
III. BSP Hikes: Short-Term Rates Surge as Treasury Yield Curve Flattens
IV. PSE Dead Cat’s Bounce on Falling Volume; Market Cap to real GDP Broke Down in 2022
V. The Fragility of the Property Sector to Higher Rates as Real Estate Prices of Two-Third of OECD Members Fall
BSP’s 15-Year High Policy Rates: How the Philippine Peso, Treasuries and the PSE Reacted; IMF on OECD’s Falling Home Prices Exhibits the Fragility of the Real Estate Sector
The BSP hiked its policy rates to a 15-year high. This outlook deals with the reaction of the Philippine peso, Treasuries & the PSE. Also, we explore the impact of OECD's falling real estate prices.
I. BSP Hiked Rates to 15-Year High in Just 11 Months!
The BSP raised its policy rate by 25 bps last week.
Although the BSP has hiked by an aggregate of 425 bps in nine months, this process has covered 11 months only! That’s historic.
And this week's increase brings the 6.25% BSP ON RRP rate to June 2007 or 15+ years levels! (Figure 1, topmost chart)
But things were considerably different between now and then. For instance, Universal and commercial bank loans have increased by about 705% from June 2007 to January 2023. That's just one of the many variances.
Also, this week's 25 bps represented a step down from its torrid pace of increases.
Since the move was within the consensus expectation, domestic financial markets must have discounted this.
But has the BSP tightened enough?
For starters, the current level of policy rates remains way below the CPI and slightly below the two-year GDP average of 6.65%. From these parameters, there is still room for the BSP to raise rates.
Yet, authorities appear to be considering a "pause" in the current hiking cycle.
In reality, they've been yearning for this—to bring back the salad days of easy money.
Why the average two-year GDP? Well, it was the period that accounted for the resurgence of the CPI.
How about the market's reaction to BSP’s actions?
II. Despite BSP Hike, US Federal Reserve Liquidity Injections Spur a Rally on the Philippine Peso and Regional Currencies
First, its impact on the Philippine peso.
This week, the peso firmed by .7%, along with most of the region's currencies (except the Thai baht). The Indonesian rupiah was Asia's biggest gainer (+1.2%).
But the BSP's hike appears to have less influence on the movements of the peso. Instead, the actions of the US Federal Reserve could have been the primary contributor.
With Fed assets ballooning due to the enormous emergency loans extended to crisis-affected banks to shore up deposits, liquidity injections have weakened the USD. US banks have been experiencing a decline in deposits. (Figure 1, middle pane)
Higher yielding Money Market Funds have drawn depositors away from lower-yielding banks. (Figure 1, lowest graph)
And the Fed has been responsible for the imbalances caused by excess deposits, as explained by the fund manager John Hussman. (bold added)
The “excess deposits” are there because the Fed put them there. The U.S. banking system has more than $1 trillion of deposits that exceed the FDIC insurance limit, and nearly $8 trillion of bank deposits in excess of bank loans, because more than a decade of “quantitative easing” took bonds out of the hands of the public and replaced those bonds with zero-interest bank deposits. Overvalued long-term securities dominate portfolios because yield-starved investors and banks couldn’t tolerate the perpetual zero-interest rate world created by the Fed, and felt forced to reach for yield. (Hussman, 2023)
Figure 2
Further, the surge in access to the Fed's emergency facilities has closed in on the heights of the Great Financial Crisis (GFC). (Figure 2, topmost window)
Additionally, an unspecified foreign central bank drew about $ 60 billion from the Fed's FIMA repo facility. Established during the COVID era, this swap facility allowed central banks which do not have swap lines access to USD. The borrower remains unidentified and has been subject to intense speculation.
The Fed's liquidity infusions resulted in the decline of the USD index by .6% this week, catapulting a risk ON momentum on the financial assets of mainly advanced economies.
Once the culprit, local authorities have now dissociated the peso's role in inflation.
Businessworld, March 24: "The Philippine central bank can focus on fighting inflation as the peso is not a problem, its governor said on Friday."
See, blame the peso when it fits the political narrative.
And though the peso has been strengthening, the Phiref interbank FX swap rates haven't come off the recent highs, which indicates insufficient USD liquidity in the banking system. Phiref rates pointed to the sharp rebound of the USD in 2021. (Figure 2, lowest chart)
Two points here. Aside from explaining the role of the US Fed in driving the peso's strength, my intent is to also show the ongoing risks abroad.
Nonetheless, we will leave the discussion of the USD peso (BoP and GIR) to another day.
III. BSP Hikes: Short-Term Rates Surge as Treasury Yield Curve Flattens
How about Philippine Treasuries?
Since the BSP continues to predict a "peak" or a turnaround in the CPI, the recent rate hike should have eased the yields of Philippine Treasuries.
Figure 3
Instead, short-term rates sold off this week, as rates in the middle and the end curve were less volatile. (Figure 3, topmost graph)
The result was to flatten the yield curve, signaling even more reduced liquidity in the financial system.
There's more. The rate hike caused an inversion of the yield curve in 10 of the 12 (83%) Treasury securities, or their yields have been lower than the present BSP policy rate. (Figure 3, middle chart)
For instance, the spread of the BSP ON-RRP rate and the 10-year Treasury yield has turned negative. (Figure 3, lowest window)
But such liquidity metrics do not represent a "one size fits all." Some sectors are more liquid than others, depending on the source of where credit expands (Cantillon Effects). For instance, with greater access to bank credit, households have bid up the prices of consumer goods and services, hence, the relatively higher liquidity for the consumers.
But as previously discussed, this access to liquidity may have reached an inflection point or could be in the process of deceleration. (Prudent Investor, 2023)
Despite rising rates, the government has likewise benefited from higher liquidity as public debt continues to carve new highs even as the banks become less liquid.
The thing is, once the reversal of the easy money regime becomes entrenched, both private and public sector credit should shrink as the private sector builds up on savings—which should be the start of a genuine recovery!
IV. PSE Dead Cat’s Bounce on Falling Volume; Market Cap to real GDP Broke Down in 2022
How about the PSE?
After eight consecutive weekly losses, the highly skewed benchmark, the PSEi 30, bounced by 2.05%.
Figure 4
But this dead cat’s rebound emerged from a dwindling weekly volume, a mixed market breadth, and concentrated pumps. (Figure 4, topmost chart)
The thing is, the PSE’s peso volume has been on a cascade since its climax in 2013. (Figure 4, second to the highest window)
The deterioration in volume reflects the faltering bank liquidity conditions.
Further, the sagging volume has reverberated with the downtrend in the index level and the diminishing YoY returns. (Figure 4, second to the lowest window)
And for the first time ever, the deeply leveraged corporate world has been confronted with spiking interest rates.
And in this context, the stock market capitalization to real GDP, or the Warren Buffett indicator, broke down from support levels in 2022—a portentous outlook. (Figure 4, lowest pane)
A sustained elevation of interest rates should heighten systemic distress that leads to more fund-raising activities, possibly channeled through liquidations.
V. The Fragility of the Property Sector to Higher Rates as Real Estate Prices of Two-Third of OECD Members Fall
Figure 5
The property sector thrives on leverage with credit involved in its end-to-end business process (sales to property development/construction and the delivery of the product).
For this reason, the property sector has signified the banking system's largest portfolio. And given the vulnerabilities of the property sector to duration, it has been the worst performer among sectors in the PSE. (Property sector was down 5% YTD as of this writing)
The BSP's rate hikes culminated at the end of 2018, ahead of the peak of the property index. Even as the BSP forced down rates to a historic low in January 2021, the property index headed south. And higher rates have only accelerated its downside momentum. (Figure 5, upper chart)
The IMF recently published its survey of OECD property prices and found that two-thirds of economies have seen a retreat in housing prices, with the scale of decline varying from nation to nation. (Figure 5, lowest chart)
And with properties entwined to the banking sector primarily as collateral, it shouldn't be a surprise that its business feedback loop covering deteriorating sales, increased inventories, falling collateral value, intensified calling back of loans and margin calls, and expanded demand for collateral could be disorderly.
Add to these more complexities; the higher risks from slower bank credit expansion, credit downgrades, counterparty risks, diminished financial liquidity, higher insolvency risks of banks and non-financials (including property firms), greater demand for capital, and increasingly guarded credit management.
The USD 64 trillion question: Up to what extent of property valuation losses can the banking system absorb before their balance sheets tip over? Of course, it varies from bank to bank. But the weak links are the first to break.
Figure 6
By extension, parts of the concerns over US small banks have been the deteriorating state of commercial property loans, which accounted for an estimated 70% of the sector's total loans. (Figure 6 upper chart)
So, could there be aftershocks in the US banking system?
And finally, when the Federal Reserve goes on a hiking streak, it usually reaches a point where the hikes break something (financials/economies/markets). (Figure 6 lower diagram)
The current episode of the credit cycle includes the UK LDI Pension Crisis in September 2022 and for now, the global banking crisis (3 US banks and Credit Suisse).
And if I am not mistaken, these represent the appetizers.
Like the US, UK, and elsewhere, local authorities have a faint idea of the repercussions of the policies they've implemented. On this point, the knowledge and calculation problems keep authorities blind to which firms, industries, or nations would be affected—even the multilateral institutions.
And typically, authorities apply band-aid therapy to the predicaments they've created, which only compounds these. Recent bailouts are great examples.
Further, until now, the consensus, who have not foreseen this inflation crisis, has stubbornly resisted the idea of stagflation.
As a parting note, my wish is that our readers would learn from events abroad, the economics behind this, and take the necessary precautions to preserve capital than pine anxiously for a return of the Fear of Missing Out (FOMO).
___
References
Hussman, John P. Ph.D. Edge of the Edge March 2023, Hussman Funds
Prudent Investor Newsletter, Philippine Core CPI Forged a New 22-year High! Signs of Peak 2nd Wave Inflation: Pullback in Bank Lending and BSP Injections, March 12, 2023; substack, blogger
