Financial Blog

As stated in our articles earlier this year, the bond markets saw “An Encouraging Start” in January, but as evidenced by February’s print, the inflation bug proved to be still alive and kicking. Indeed, the ghost of 2022 is haunting the financial markets once again. Philippine inflation blew past all expectations as January inflation rose 8.70% vs 7.60% market consensus, with supply side pressures remaining the biggest concern as food prices continue to be elevated.

On the other hand, US bond rates, which saw one of its strongest start in years, erased all its gains in the last month, with the US 10Y note trading at a YTD high of 3.88 – 3.97%. Consequently, local bond yields followed suit and gave back some of the gains in January but remain lower YTD by 30-60 bps.

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Bond Markets remain Resilient and Constructive

Despite hawkish Federal Reserve (FED) officials talking up inflation, fixed income markets remain resilient. The Bangko Sentral ng Pilipinas (BSP) raised overnight rates by 50 bps, which was higher than what was initially expected. The BSP is expected to end their tightening cycle at 6.25 – 6.50%, which is higher than the initial forecast of 6.00%. The FED also expects a higher terminal rate at 5.25 – 5.75% from 5.00 – 5.25%. Despite the overall adjustments by most Central Banks globally, the general outlook remains positive in the fixed income space.

Inflation remains stubborn like an itch that just won’t go away, but just like any other occurrence, it’s not going to last forever. In fact, if we just consider  the base effects alone, inflation is already expected to subside by the 2^nd half of 2023.

Moreover, as numerous studies suggest, there is a time lag as to the impact of rate hikes, falling usually anywhere between a 7-to-18-month time frame.  Hence, we may just be starting to feel the effects of the massive rate hikes implemented last year.

Demand for bonds is starting to grow exponentially as the rich and elevated yields prove to be attractive. This is evident in the consistently strong demand seen in local bond auctions by the Bureau of Treasury (BTr) which saw a bid-to-cover ratio of 2-4x oversubscription. Some may mention that current RPGB 10Y paper is not attractive at the 6.25% handles, considering that the BSP is expected to raise rates at the same level. If taken at face value, it may appear not to be attractive, but from an investment point of view, it makes a compelling and sensible investment. Local inflation is expected to subside back to the  2 – 4% range by 2024 and with that, the BSP is likely to lower rates as well and investing in that aforementioned RPGB 10Y paper with a 6.25% yield will have been akin to striking  a gold mine.

Thus, it is not  surprising to see that demand continues to grow as rates are not expected to remain elevated for a longer time.

Recession is the Bond Market’s Friend

Major US indices saw a massive correction last month — the Dow was down almost 4% last February as higher rates strengthened the probability of a possible recession this year. The base case for 2023 is a mild recession for developed countries, which is why the general expectation for the year would be a bounce for both the equity and bond markets. As the market narrative shifts more from inflation towards recession in Developed Economies, risk assets like equities might be placed at risk, with the pull of gravity throwing its net across countries, including Emerging Markets.

In contrast, bonds could benefit given the same narrative. A worse-than-expected recession would mean that the FED will pivot earlier than expected which would therefore impact the bond markets in a positive way. Rate cuts brought about by growth concerns would impact the bond markets first and will support the lower rates down the line.

Image: US Recession Probability: 60%-67%

Bonds overall will benefit from a pause in the tightening cycle but could benefit even more in a recessionary environment. Bond funds have continued to generate positive returns in a tumultuous 2023 environment and we believe outlook remains favorable moving forward despite the volatility seen this year.

To learn more about Bond Funds, you may go to:

SB Peso Bond fund: https://www.securitybank.com/personal/investments/unit-investment-trust-funds/sb-peso-bond-fund/