Angelo Taningco
Economist, Treasury Group

Key points

• Risk-off sentiment spurred by escalating trade wars triggered by US. Global oil prices remain elevated amid OPEC’s decision to lower spare capacity and US pressuring allies to limit oil imports from Iran. Global equity markets and EM currencies tumbled.
• Q1 GDP growth revised downward for US and Japan on reduction in household spending, left unchanged for euro area. Growth to rebound in Q2 as seasonal factors fade.
• US inflation quickens, seen to overshoot Fed’s target. Euro area’s inflation accelerates, still below target. Inflation in China and Japan little changed, torpid.
• Fed raised rates for 2^nd-time this year in June, signals a hawkish policy stance with steeper rate hike path on more upbeat US economic outlook. Two more US rate hikes expected this year. UST yield curve flattened further.
• ECB kept key interest rates unchanged, asset purchase program to be trimmed in Q4, end by 2019. BOJ maintains monetary policy settings.
• Philippine headline inflation forecasted to climb to 4.8% in June from 4.6% in May. BSP’s inflation forecast range for June: 4.3% – 5.1%. Price pressures seen to come from food supply constraints, elevated oil prices, peso weakness. Money supply growth inched up, bank lending growth decelerated in May.
• BSP raised its policy rate by 25bps for second-consecutive time in June to 3.50%, aimed at managing inflation and peso volatility. Expected to hike rates in Q3—as early as August—on rising inflation expectations.
• Philippine cumulative fiscal deficit at P105.9b in Jan-Apr, below target on improved tax effort. GS yields rose, curve shifted upward and steepened in June on rising inflation expectations. Yields seen to climb further in anticipation of another BSP rate hike. RTB issuance generated P122b.
• BOP deficit widened to $2.1b in Jan-May on trade deficit and financial outflows. Trade-in-goods deficit ballooned in Jan-Apr, outweighing OF cash remittances. Foreign reserves down to $79.2b at end-May. Peso depreciated 1.5% mom in June, 6.4% ytd. End-2018 USD/PHP forecast revised up to 53.25.

Global Developments & Outlook

Oil prices elevate, trade war escalates. Oil and trade heavily influenced financial markets in June. Global oil prices remained elevated and have ascended during the last week of the month, triggered by United States (US) calling for its allies to restrict their oil imports from Iran as well as shrinking of US oil inventories. This occurred despite a joint decision by OPEC and non-OPEC participants to reduce spare capacity and boost oil production by about 1 million barrels (bbl) per day.

Global trade war is escalating as trade frictions between US and the rest of the world have intensified. This started with US tariffs on global aluminum and steel that took effect in June. US-China trade skirmish began to worsen with US announcements to impose 25% import tariffs on up to $50 billion (b) of Chinese goods containing “industrially significant technologies” starting July as well as to provide restrictions on Chinese investments in US technology. US has likewise threatened to levy import duties on an additional $200b of Chinese products. China vowed to retaliate with the “same scale and intensity.” US is also planning to impose 20% import tariffs on European Union (EU) cars; this was in response to EU’s imposition of 25% tariffs on $3b worth of US goods that was in retaliation to US steel and aluminum tariffs. As a consequence, market volatility increased with equity markets tumbling in G3 economies as well as in China, which slipped into bear market territory. The risk-off sentiment on EMs has spurred the drop in MSCI’s indices on EM equities and currencies.

Q1 GDP growth revised downward for US and Japan, unchanged for euro area. US Q1 GDP growth was revised downward by 0.2 percentage point (pp) to 2.0%—its “third” and final estimate—contrary to market’s expectation of no change. The reduction was due to lower-than-previously estimated growth in personal consumption expenditures (PCE) and private inventory investment. Nevertheless, the US Bureau of Economic Analysis reported that the economic growth’s overall picture is still the same.

Similarly, Japan’s Q1 GDP growth was adjusted downward by 0.2pp to −0.6% mainly due to private consumption now estimated to have contracted in Q1 as opposed to previous estimate of flat growth. In contrast, euro area’s Q1 GDP growth rate was left unrevised at 2.5% yoy.

Inflation rises in US and euro area, little changed in Japan and China. US inflation rose further in May with headline CPI inflation at 2.8% yoy versus 2.5% in April while core CPI inflation nudged higher to 2.2% from 2.1%. Similarly, PCE inflation is expected by market to rise also in May, i.e., to 2.2% yoy from 2.0% for headline and to 1.9% from 1.8% for core. These US inflation trends show that the Federal Reserve’s 2% target will very well be breached over the very near term.

In the euro area, inflation gained traction as well with CPI inflation at 1.9% yoy in May from 1.2% in April (headline) and at 1.1% from 0.7% for core. Still, latest inflation of the euro area is still below the European Central Bank’s (ECB) 2% target. In contrast, headline CPI inflation for China and Japan remained torpid, staying flat at 1.8% yoy in May for the former and nudging higher to 0.7% yoy in May from 0.6% in April for the latter; in both economies, the latest inflation rates are well below their central banks’ targets of 3% and 2%, respectively.

FOMC raises policy rate in June, undertakes “hawkish” stance. The Federal Open Market Committee (FOMC) raised the target range of the federal funds rate by 25bps to 1.75% – 2.00% on 14 June, the second time for the year. The rate hike was expected by the market. In addition, the Federal Reserve released its latest projections that signaled a more upbeat economic outlook. It signaled a “hawkish” stance with its steeper rate hike path as majority of the Fed officials prefer 2 more rate hikes this year, 3 next year, and 1 more in 2020. With this latest development, we revise up our US rate hike forecasts for this year to mimic the Fed’s rate hike path. As for next year, we think there will be only 2 rate hikes, which is 1 less than the Fed’s projections.

UST yield curve flattens further. US Treasury (UST) yield curve flattened further in June as short-end rates rose amid Fed’s rate hike and hawkish tone while long-end yields were down due to dimming US long-term growth outlook on rising trade tensions between US and rest of the world.. The 2yr-10yr yield spread narrowed by 10bps mom to 32bps.

ECB holds key rates and turns dovish, announces timeline for unwind of asset purchase program. BOJ keeps monetary policy settings unchanged. The European Central Bank’s (ECB) Governing Council decided on 14 June to maintain key interest rates and expect these to stay at their current levels at least until summer of next year, signaling a dovish tone. It also announced its monthly net asset purchases to be trimmed from EUR30b to EUR15b spanning the last quarter of this year, and to end starting next year. The Bank of Japan’s (BOJ) Policy Board decided on 15 June to keep unchanged its yield curve control and asset purchase program. Again, Japan’s benign inflation is likely to be the reason for the sustained accommodative monetary policy.

Philippine Developments & Outlook

Business confidence down for Q2, Q3. Business sentiment waned with its indices for current and next quarters down on a quarter-on-quarter (qoq) basis. Firms’ optimism for Q2 was supported by expectations of stronger tourism demand, school enrollment, harvest season, bigger production orders and product line expansion, and government’s infrastructure projects. Meanwhile, the decline in business sentiment was sharper for the next quarter on more concerns over potential business interruption during rainy season, higher commodity prices, and less household spending on products other than education.

Employment improves in April. Number of employed persons rose 1.6% yoy to 40.9m in April, allowing the unemployment rate to shave off 0.2pp in a span of 12 months to settle at 5.5%. There were increases in the number of employed in industry and services sectors, and we think this has contributed to the strong output performances of the aforementioned sectors. We computed the average unemployment rate spanning the January-April period at 5.4%, which is 0.1pp lower from our 2018 forecast; given this, we hold on to our 5.5% projection for this year. Meanwhile, we believe that there would be minimum wage hikes across several regions this year in order to support workers’ purchasing power in light of sharper increases in consumer prices. The need for workers to augment their income to address rising inflation is evident in the 0.9pp yoy increase in the underemployment rate to 17.0% in April.

Inflation nudged higher in May, forecasted to rise further in June. The 2012-based yoy headline and core CPI inflation rates both climbed 0.1pp mom to 4.6% and 3.6%, respectively, in May. For the first five months of the year, headline CPI inflation averaged 4.1%, breaching the upper end of the government’s target range. Economic managers of government have stated that inflation has slowed down as the mom inflation rate plunged to 0.0% in May from its January-April average of 0.7%. However, we still believe that yoy inflation will continue to climb further in the next couple of months due to food supply constraints, elevated oil prices, hikes in minimum wages and transport fares, and sharp peso depreciation.  For the month of June, we project headline CPI inflation to be at 4.8% yoy.

Policy rate increased for 2^nd-straight time in June, calling for another hike in Q3. Following the 25bps policy rate hike by the Bangko Sentral ng Pilipinas (BSP) Monetary Board on 20 June, we believe that another rate increase of the same magnitude is warranted given our views that inflation expectations will continue to climb further; and that depreciation pressures on the peso will not fade away especially that the FOMC is expected by the market to raise rates two more times later this year. As such, we expect a 3^rd rate hike in Q3, as early as 9 August, to lead the policy rate to reach 3.75%.

Domestic liquidity growth edged up, bank lending growth decelerated in May. Bank lending growth (net of reverse repurchases) decelerated to 19.4% yoy in May from 19.9% in April whereas M3 money supply growth inched up to 14.3% from 14.2% in the same period. Overall, we assessed domestic liquidity to remain ample with bank lending still vibrant.

Total funds placed in the reverse repurchase, overnight deposit, and term deposit facilities (TDF) increased by P109b mom to P523.8b at end-May. In June’s TDF auctions, there was relatively strong demand for the 7-day as opposed to the 14- and 28-day tenors. Between May and June, the average bid coverage ratio increased for the 7-day but declined for the 14- and 28-day tenors. The average yields climbed for all three tenors in June with the last weekly auction for the month fetching 3.75% for the 7-day tenor, 3.87% for 14-day, and 3.85% for 28-day.

Fiscal balance reverts to deficit in May, short of target on improved tax effort. Fiscal balance was in a P32.9b deficit in May following its P46.3b surplus in April; this led its Jan-May deficit to level off at P138.7b, which is 32% less than the government’s target. On a cumulative basis, government revenue collections were strong (19% yoy) and we ascribe this to the first tax reform package (TRAIN). Government spending was likewise robust (25% yoy) and we associate this to the government’s Build, Build, Build program.

We maintain our fiscal deficit forecast of P440b or 2.7% of GDP for this year. Using a regression model, we empirically established a positive relation between tax effort (tax revenues as % of GDP) and fiscal balance (as % of GDP), and found that the improvement in the tax effort at the start of the year was due to TRAIN and tax administration reforms and has led the fiscal deficit to remain at manageable levels amid government’s strong infrastructure push with its Build, Build, Build program. We assert that the fiscal performance bodes well for the country’s credit rating.

BTr partially awarded T-bills, 7Y and 20Y T-bonds. RTB proceeds more than P100b. GS yields rose, curve steepened in June. Bureau of the Treasury’s (BTr) weekly auctions of government securities (GS) in June had partial awards for Treasury bills (T-bills) and for re-issued 7- and 20-year Treasury bonds (T-bonds). BTr raised P45.9b out of its P60b T-bill offering in June. The 91-day T-bill was fully awarded in its first two weekly auctions for the month, rejected and partially awarded in the third and fourth auctions, respectively. The 182-day tenor was fully awarded during the first three weeks but partially awarded in the last auction, while 364-day maturity was partially awarded across all auctions. Average rates for the 91-, 182-, and 364-day T-bills climbed 18, 17, and 23bps, respectively, during the month.

On T-bonds, the re-issued 7-year tenor with 5.75% coupon was partially awarded (P7.6b out of P10b) at 5.976% yield on 13 June; the re-issued 20-year security with 6.5% coupon was partially awarded (P4.1b out of P10b) at 6.979% yield; and the P10b 5-year bond offering with 5.5% coupon was rejected on 26 June. The BTr raised P121.8b worth of 3-year Retail Treasury Bonds (RTBs) on 13 June. It initially auctioned P66b of RTBs on 30 May and generated additional P55.8b during the 30 May – 8 June offer period.

GS yields rose across all tenors in June due to market’s expectations of accelerating domestic inflation and policy rate hikes both locally and the US. The GS yield curve shifted upward and steepened from the previous month with the 10yr-2yr yield spread widening 12bps mom. We still foresee GS yields to rise further on higher future inflation and expectation of more rate hikes.

BOP deficit bigger in Jan-May, foreign reserves down for 2^nd-straight month in May. The balance of payments (BOP) incurred a deficit position for the fifth-straight month in May, amounting to $583m as foreign reserves again contracted during the month. The cumulative BOP deficit for the first five months of the year stood at $2.1b, which is already higher than the BSP’s revised BOP deficit forecast of $1.5b for this year.

We believe the BOP deficit is widening largely due to the trade-in-goods deficit, which already ballooned 59% yoy to $12.2b in January-April. Meanwhile, overseas Filipinos (OF) cash remittances reached $9.4b in January-April, posting 3.5% yoy growth, but was not enough to offset the merchandise trade gap.

Gross international reserves (GIR) stood at $79.2b at end-May, enough to cover 7.6 months of import requirements and 6.2 times of short-term external debt obligations.

USD/PHP breached 53, depreciated 1.5% mom and 6.4% ytd in June. The Philippine peso’s rate of depreciation was 1.5% mom in June, leading the USD/PHP to close the month at 53.34. The USD/PHP breached 53 on 13 June and reached its highest level for the year at 53.52 on 28 June. On a year-to-date (ytd) basis through end-June, the peso depreciated by 6.4%, the second-worst performing currency in Asia. Amid the relatively fast pace of peso depreciation sparked by EM risk-off sentiment, we adjusted upward our end-2018 USD/PHP forecast to 53.25.

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