The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance— Taylor Caldwell, (often misattributed to Marcus Tullius Cicero)
In this issue
Marcos-nomics stimulus: Yields of the Philippine Treasury Curve Plunged, The Turbocharging of Pre-Election Liquidity Growth
I. The Radio Silence on Last Week’s Collapse of the Philippine Treasury Yield Curve
II. What a Bullish Flattener Implies
III. How Rate Cuts Could Affect the Health of the Philippine Banking System
IV. Mounting Economic Fragility: Higher May Unemployment Rate and the Rising Dependence on Government Jobs
V. Mounting Economic Fragility: Elevated Trade Deficit, Softened FDI Flows in April, and Stagnant Manufacturing Sales
VI. "Marcos-nomics stimulus:" The Turbocharging of Pre-Election Liquidity Growth
Marcos-nomics stimulus: Yields of the Philippine Treasury Curve Plunged, The Turbocharging of Pre-Election Liquidity Growth
The collapse in the yields of the Philippine Treasury Markets highlights the BSP's upcoming rate cuts, which, along with May's spending and liquidity growth spike, represents the "Marcos-nomics stimulus."
I. The Radio Silence on Last Week’s Collapse of the Philippine Treasury Yield Curve
Last week, significant developments in the Philippine treasury markets went largely unreported by the media and the echo chamber. Despite this, the implications of these changes are significant for the country's economy.
Figure 1
One. T-bill rates remained steady, while yields on Philippine notes and bonds plunged, deepening the "bullish flattening" process that we have been pointing out. (Figure 1, topmost window)
Two. The entire Philippine treasury curve has traded below the Bangko Sentral ng Pilipinas' (BSP) overnight reverse repurchase rate (ON-RRP). (Figure 1, middle image)
Figure 2
Three. The steep drop in 10-year Philippine treasury notes last week was the most pronounced in the (ASEAN) region, even surpassing the recent declines seen in US Treasury counterparts. (Figure 1, lowest diagram, Figure 2, upper graph)
In essence, treasury traders have reinforced indications that the BSP is preparing to lower rates.
You heard this first here.
II. What a Bullish Flattener Implies
Yet, a bullish flattener can be seen as a sign of different things depending on the context.
In the BSP’s latest Financial Stability Report (FSR), a bullish flattening curve represents "Longer-term outlook is improving and investors price-in lower rates. This gives the central bank room to lower the policy rate" (BSP, 2023)
For Wellspring Financial Advisors, "We have historically seen bull flattening leading into a recession. This can often happen because of a flight to safety trade and/or a lowering of inflation expectations " (Bruss, 2023)
Last we noted that "T-bill rates have been coming off their recent highs, and the narrowing of the treasury curve or a "bullish flattening" has highlighted weaker inflation and slower GDP growth, supporting the BSP's desired rate cuts" (Prudent Investor, 2024)
The point is, while not a direct indicator of economic conditions or inflation, the treasury yield curve provides a crucial insight depending on prevailing economic and financial circumstances.
Nonetheless, the following factors may be relevant to the present conditions:
First, the fact that rates have been tumbling translates to the treasury markets expecting an easing of monetary policy. Rate cuts can only be justified by diminishing inflation rates.
Second, lower inflation expectations increase the demand for longer-term securities. (ceteris paribus)
Third, it could also signify slowing economic growth or increasing risk aversion (even flight to safety).
Fourth, it may imply accruing imbalances in the supply and demand for Philippine treasuries.
III. How Rate Cuts Could Affect the Health of the Philippine Banking System
How will this affect the banking system?
One. The illusion of debt-financed spending utopia.
While lower rates could boost the GDP in the immediate term through increased credit expansion, allowing for expanded financing of Keynesian desired spending, this is contingent upon the capacity of balance sheets to absorb higher leverage.
For instance, unlike in 2008-2017, the serial BSP rate cuts in pre-pandemic 2019 haven’t exactly bolstered bank lending, which in contrast, declined due to the scourge of hidden NPLs. (Figure 2, lower pane)
Only the BSP’s historic Php 2.3 trillion liquidity injections backed by the unprecedented relief measures reversed it in 2021.
Powered mostly by consumer loans, universal commercial bank lending soared by 10.2% in May 2024—the strongest growth since March 2023.
Much of the current strength in bank lending is due to 'refinancing' or debt 'rollovers,' which is why the Consumer Price Index (CPI) remains subdued.
Ironically, the establishment brands this debt expansion as 'restrictive.' Incredible.
In the absence of this vigorous credit expansion, think of what would happen to inflation and GDP.
The thing is, spending will be determined by balance sheet conditions over time, rather than just rates alone.
Two. A temporary boost on investments.
With surging fixed-income prices, it may also boost the banking industry’s investment side of the balance sheets.
Figure 3
It may also temporarily lower the industry’s camouflaged mark-to-market losses in the context of held-to-maturity (HTM) assets. (Figure 3, topmost chart)
However, HTMs showed minimal improvement when 10-year yields plummeted in 2022-2023, confirming the trend observed from 2019 to 2022, where a crash in rates resulted in negligible progress for the bank’s HTM assets.
Three. An adverse impact on the bank’s interest margins.
Furthermore, the narrowing bond spreads should also lead to tighter interest margins for banks as the 2019-2020 experience showed, which means lesser incentive to lend. (Figure 3, middle graph)
Lastly, falling rates expose disguised credit risks.
During 2019-2020, the BSP rate cuts were in response to mounting pressures from credit delinquencies in the banking system. While the pandemic recession exacerbated the situation, BSP's comprehensive measures—combining rate cuts, liquidity injections, and various relief efforts—masked the true extent of NPLs. (Figure 3, lowest pane)
Despite some of these relief measures and subsidies in place, the recent resurgence of NPLs have been pressuring the BSP to consider such rate cuts.
Figure 4
In short, the BSP rate cuts would whet the speculative appetite of banks and financial institutions for "investments," while reducing their core "lending" operations (similar to the rate cuts of 2019-2020) (Figure 4, topmost image)
Most importantly, higher interest rates have exacerbated the servicing costs associated with record-high levels of public debt, indicating a potential reduction in GDP growth driven by lower public spending over time.
Despite its ever-shifting or ambivalent stance, the BSP has been advocating for lower rates. Several economic data released last week help explain this push.
Firstly, despite the recent record-high employment rates, labor markets continue to face challenges.
While the unemployment rate rose from 4% in April to 4.1% in May, this increase was primarily due to a rise in the labor force participation rate. The employed population actually increased by 510,000 month-over-month (MoM), but a larger increase in the labor force by 576,000 led to an uptick in the unemployment rate. (Figure 4, middle visual)
However, a broader analysis reveals emerging tensions in labor participation rates.
It seems odd to see a job boost in the investment-starved agricultural sector reportedly suffering substantial losses from El Nino. Yet, the government bannered Php 9.6 billion in investment gains this month (mostly from the elites).
Furthermore, the government was the largest contributor to job gains. Aside from construction jobs stemming partly from government infrastructure projects (including PPPs), the government and defense sectors saw significant gains in both May and March. (Figure 4, lowest chart)
Even assuming its accuracy, this data provides clues as to why consumers have been struggling, contradicting the headline trend of "full employment."
V. Mounting Economic Fragility: Elevated Trade Deficit, Softened FDI Flows in April, and Stagnant Manufacturing Sales
Next, external trade retraced much of its April advances in May.
Figure 5
Import growth fell from a 13.01% increase in April to a negative 0.03% in May, primarily due to an 11.5% plunge in capital goods imports, while consumer goods imports only rose by a meager 0.42%. Capital and consumer goods accounted for 25.6% and 19.6% of the total share, respectively. (Figure 5, topmost pane)
Export growth also dived from a 27.9% growth spike in April to a 3.08% contraction in May.
While Artificial Intelligence (AI) has boosted global semiconductor trade, with exports increasing by 19.3% year-over-year (YoY) and 4.1% month-over-month (MoM) in May, Philippine semiconductor exports saw an incredible collapse from a 30.7% YoY growth spike in April to a 13.3% contraction in the same month! Microchip exports accounted for 43.4% of the total share. (Figure 5, middle graph)
Thirdly, despite periodic junkets by the leadership, which reportedly led to significant investment pledges from key geopolitical partners like the US and NATO, April's Foreign Direct Investments (FDI) fell by 36.9%, but overall YTD growth was up still 18.7%. Debt made up significant proportions of both April's and YTD FDIs: 73.2% and 63.5%, respectively. What happened to these investment promises? (Figure 5, lowest chart)
Also, debt-driven FDI flows do not automatically translate into 'investments' and could serve other purposes. Some might declare it as such to the government to avail of incentives.
Lastly, FDI flows exhibit a downtrend.
Figure 6
Finally, domestic manufacturing remains stagnant, with production values and volumes increasing by 2.2% and 3.2% respectively in May (YTD: -0.1% and +0.9%). However, these gains may be offset by declining sales values and volumes, which saw decreases of -1.5% and -0.3% in May (YTD: -1.4% and -0.3%). (Figure 6, topmost graph)
Imports have partially filled the slack in domestic production, which is the essence of the trade deficit.
Overall, weak imports and a manufacturing stupor manifest a fragile domestic demand.
In a nutshell, despite optimistic projections by the echo chamber, even government data suggests a critical shortage of investments and an increasing dependence on debt supporting the real (not statistical) economy.
Moreover, deepening dependence on the government to stimulate GDP growth, evidenced by near-record "twin deficits," could lead to heightened inflation, higher future taxes, and magnified reliance on external debt. (Figure 6, middle chart)
It is not helpful when the establishment confuses the GDP with the overall economy, for the simple reason that the GDP has been skewed to reflect the growth of the government and the elites—the "trickle-down syndrome."
VI. "Marcos-nomics stimulus:" The Turbocharging of Pre-Election Liquidity Growth
Could the public spending spike observed in May 2024 signify a potential precursor to a "Marcos-nomics stimulus" program?
Meanwhile, infrastructure, public defense-related projects, pre-election expenditures, and bureaucratic spending were likely funded by the national government, which saw a 22.3% spike in disbursements in May.
This contributed to a 14.8% surge in national government spending over the first 5 months, reaching an all-time high nominal level of Php 1.443 trillion!
So if we are not mistaken, "Marcosnomics" will be heavy on political expenditures but sold to the public as a "stimulus." (Prudent Investor, 2024)
May 2024 marked the fourth highest spending on record, which significantly boosted the BSP’s principal measure of liquidity, M3, to 6.5%, a six-month high.
Figure 7
A substantial portion of this liquidity growth stemmed from cash in circulation, which surged to its second-highest level on record, surpassing the zenith of December 2022. (Figure 7, topmost image)
Traditionally, December has been the peak for M3 annually. However, this time could be different. If May’s spending trend continues, nominal cash levels may surpass the historic highs of December 2023 even before year-end!
May’s cash growth rate of 6.1% YoY was the highest since December 2022’s 7.6%.
For want of doubt, the administration has begun injecting large amounts of cash into the financial system.
Together with the accelerating growth in the banking system’s loans, the BSP’s net claims on the central government (NCoCG) surged by 89.21% in May, while the bank's NCoCG slowed to 12.2%. (Figure 7, middle graph)
This combined financing of government deficit spending and private sector borrowing or formal credit expanded by 9.44% to a record Php 27.02 trillion in May!
And yet, all we can hear from the consensus is that this represents a “restrictive environment!”
The thing is, if May’s deficit spending-driven liquidity growth will be sustained, it should put a floor on the present private sector-powered disinflationary impulses—with a time lag.
The Philippine treasury markets have signaled that the BSP may be about to confirm the unannounced "Marcos-nomics stimulus" with upcoming rate cuts.
However, such stimulus could also reinvigorate the third wave of the incumbent inflation cycle. (Figure 7, lowest chart)
Stay tuned.
___
References
FINANCIAL STABILITY COORDINATION COUNCIL, 2023 FINANCIAL STABILITY REPORT December 2023, p.35 bsp.gov.ph
Kevin Bruss Steepening and Flattening of the Yield Curve, Wellspring Financial Advisors, August 10, 2023; wellspringadvisorsllc.com
Prudent Investor, June CPI’s Decline Reflects Demand-Side Slowdown: Will the BSP Join Global Peers in Easing Policies, and Will the Government Pursue 'Marcos-nomics Stimulus'? July 7, 2024
Prudent Investor, Could the Philippine Government Implement a 'Marcosnomics' Stimulus Blending BSP Rate Cuts and Accelerated Deficit Spending? Substack.com June 30, 2024
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