Vaccines, inflation, and GDP recovery to drive financial markets this year

By Michelle Anne P. Soliman

THE FOURTH QUARTER of 2020 saw local financial markets rebound somewhat with reports of the COVID-19 (coronavirus disease 2019) vaccine developments and expectations of economic recovery driving performance during the period.

The peso averaged P48.27 against the dollar in the October to December period, appreciating 1.37% from the previous quarter’s average of P48.94:$1, Bangko Sentral ng Pilipinas (BSP) data showed. Likewise, the local unit appreciated by 5.4% compared with the P50.99-to-a-dollar average seen in the fourth quarter of 2019.

Meanwhile, Treasury bill (T-bills) auctions conducted in the last three months of 2020 saw robust demand with total subscriptions of reaching around P918.91 billion, which is around four times the P230-billion aggregate offered amount. This oversubscription amount of P688.91 billion was higher compared with the P626.08 billion posted in the previous quarter.

Similarly, auctions of Treasury bonds (T-bonds) during the period had a total subscription amount of P453 billion, around 2.5 times more than the offered amount of P180 billion.

At the secondary market, domestic yields were lower by a range of 4.8 basis points (bps) for the 91-day T-bill to 29.30 bps for the three-year T-bonds compared to end-September 2020 levels.

Quarter on quarter, most of the tenors saw their yields fall except those for the 10-, 20-, and 25-year debt papers, which rose by 1.6 bps, 8.9 bps, and 7.4 bps, respectively. Yields were lower by an average of 12.28 bps during the reference period, according to the PHP Bloomberg Valuation Service Reference Rates published on the Philippine Dealing System’s website.

For equities, the benchmark Philippine Stock Exchange index (PSEi) closed at 7,139.71 on Dec 29, 2020, 21.8% higher compared with the PSEi close of 5,864.23 on Sept. 30, 2020.

In an e-mail to BusinessWorld, the BSP said movements in the fourth quarter were driven mainly by macroeconomic developments as well as the developing COVID-19 situation in the country and the government’s policy measures in response to the pandemic.

“Positive developments on vaccine advancements would continue to positively impact the financial markets. Information on existing vaccines’ efficacy to the new virus strain would significantly boost market confidence. Vaccines could potentially steer the domestic and global economy towards recovery,” the BSP said.

For the equities market, the BSP pointed to various factors, which include among others the improvements in the earnings performance of listed companies in the third quarter, the optimism surrounding the prospects of an economic rebound following plans to gradually reopen the economy, the expected pickup in spending amid the holiday season, and the central bank’s implementation of further monetary stimulus measures such as the P540-billion provisional advances to the National Government and the 25-bp policy rate cut in November last year.

“Meanwhile, local firms opted to tap the bond market as an alternative funding option amid the tightened lending requirements as banks manage their capital and nonperforming loans,” the BSP added.

On the other hand, the central bank said the lingering difficulty in procuring vaccine doses in developing countries posts a downside to this outlook.

“The Philippines and Vietnam, for instance, have only secured doses for 5.1% and 6.2% of their populations, respectively. Though this may have already improved as negotiations continue with vaccine manufacturers,” it said.

Moreover, the BSP noted the emergence of the new virus strain “can necessitate prolonged restrictions on movement and economic activities.”

“This can further strain economic recovery and result in volatility in financial markets. For countries struggling to contain outbreaks, this can prolong the economic pain,” the BSP said.

“Good management of the vaccine drive will be essential, especially for developing markets such as the Philippines…,” it added.

While these factors affecting financial markets could potentially linger in 2021, the central bank looks to the proposed implementation of fiscal reforms such as the Government Financial Institutions Unified Initiatives to Distressed Enterprises for Economic Recovery (GUIDE) bill, which seeks to provide financial assistance to distressed micro, small and medium enterprises;  and the Financial Institutions Strategic Transfer (FIST), which seeks to help banks and other financial institutions recover from potential losses.

Meanwhile, private sector economists see inflation as a major indicator that could affect growth.

“The higher-than-expected uptick in domestic headline inflation may altogether keep monetary policy rates at all-time low as the BSP juggles that difficult job of helping the economy recover and keeping price stability,” UnionBank of the Philippines, Inc. Chief Economist Ruben Carlo O. Asuncion said.

Bank of the Philippine Islands Lead Economist and Vice-President Emilio S. Neri, Jr. said they are observing upside risks which will likely prop up the inflation rate above three percent in the coming months.

“The distribution of vaccines around the world in 2021 may lift global demand and push oil prices higher. However, even at current levels ($47), oil is expected to register a 180% year-on-year increase in the second quarter given the low base from last year,” Mr. Neri said.

Headline inflation stood at 3.5% in December 2020, bringing the average inflation for the year to 2.6% — matching the BSP’s forecast for the year, but still faster than the 2.5% recorded in 2019.

To recall, the average inflation rate registered in 2018 at 5.2%, the fastest since 2008’s 8.2%, was driven by swelling crude oil prices in the world market.

“Inflation is fast becoming an issue and will likely threaten the economic recovery,” said ING Bank N.V. Manila Senior Economist Nicholas Antonio T. Mapa, adding the upcoming presidential elections in 2022 may also affect market sentiment this year with “increased spending and political maneuvering.”

Rizal Commercial Banking Corp. Chief Economist Michael L. Ricafort looks to increased infrastructure this year to pump-prime the economy as supported by the timely approval of the 2021 national budget, as well as the extension of the appropriation/funds availability for 2020 national budget to end-2021 and for the Bayanihan II to end-June 2021.

Of the P4.506-trillion 2021 national budget, the Department of Public Works and Highways was given the second largest allotment of P694 billion, following the health sector with P287 billion.

PROSPECTS FOR GDP RECOVERY
The country’s gross domestic product (GDP) shrank by a record low 9.5% in 2020 — the fastest year-on-year decline since the 1940s — following the 8.3% contraction posted in the fourth quarter.

For this year, Mr. Neri expects the GDP to still contract, albeit at a slower pace than what was seen in 2020. He also considered the possibility of a double-digit growth in some quarters, assuming the government will refrain from imposing stricter quarantine restrictions.

“Given all these, our baseline forecast for 2021 is now at 6.8% as the [fourth-quarter] print exceeded our expectations. However, even at this brisk pace, economic output will not be able to return to the 2019 level yet and a full recovery may only happen in 2022…,” he said.

Meanwhile, Mr. Asuncion expects better GDP performance this year to drive financial markets this year.

“Historically, equities move up when the economy performs better. Fixed-income markets, like today in this crisis, take advantage of profit opportunities, not on the long-end but on the short and belly of the curve. Players will wait for better prospects before deciding to position longer. For forex, if the economy performs better, it is expected that the Peso will depreciate and help trade perform better,” Mr. Asuncion said.

Mr. Mapa shared this view, adding government spending and the Treasury’s borrowing program “will also come into play” although neither would likely figure in the country’s economic performance at the onset.

Mr. Ricafort said further reopening of the economy will lift hopes of coming back to the 6% growth trajectory. “The negative GDP base for 2020 at -9.5% would mathematically increase the odds of a GDP growth of at least 6% for 2021, provided that the economy reopens further, including easing of some restrictions of public transportation that allows greater productivity for the labor force…,” he said.

With these in mind, see the BSP’s and analysts’ outlook for each of the key markets.

FIXED-INCOME SECURITIES
BSP: Domestic bond market is expected to be liquid and have robust demand as the BSP continues to ensure the proper functioning of financial markets. With the market flushed with liquidity and with lingering uncertainty, some (most) market players will possibly continue placing funds in safe havens, as evidenced by the high oversubscription consistently seen in the weekly Bureau of the Treasury (BTr) auctions.

Security Bank Corp. Chief Economist Robert Dan J. Roces: For [the first-quarter of 2021], while the economy is projected to pick up this year, the pace looks slow while downside risks remain with regard to the rising COVID-19 cases as well as issues with vaccine procurement. In the meantime, we expect yields to be range-bound with a slight upward bias. As usual, volatility may be triggered by RTB’s (retail T-bonds), policy rate signals, and black swan events.

Mr. Asuncion: Market will look to the BSP and what will be its next move: to cut further or to hold for a long time. Steeper US treasuries pushing BTr to accept incrementally higher long bond yields amid rising inflation risk providing guidance on direction of longer-tenor bonds.

Mr. Ricafort: The sustained and lingering excess liquidity in the financial system would help keep short-term interest rates relatively low. Further monetary easing measures remain possible to do more of the heavy lifting for the economy amid the limited funds for any additional stimulus measures. Federal Reserve officials signalled that the key Fed Funds Rate could remain at the record low of 0.00%-0.25% over the next two to three years in able to help support economic recovery after the COVID-19 pandemic by way of lower borrowing costs.

Mr. Mapa: We may see a steepening of the yield curve with inflation forcing a correction for longer dated issues with short dates still anchored due BSP’s accommodative stance.  Increased borrowing by the BTr or any other development that may cause tightening of liquidity conditions may also force the entire yield curve higher.   

Mr. Neri: BSP officials have suggested that they intend to keep interest rates low until the economy returns to its pre-pandemic growth rate, so there’s a chance that government securities rates will stay at current levels. But then higher inflation in the coming months and government borrowings to fund deficit spending may pose a challenge and may cause the yield curve to steepen. The market also looks to the fiscal stimulus program of the incoming Biden administration, and its impact on US debt yields as well.

EQUITIES
BSP: In 2021, the PSEi is expected to continue to rise amid expectations of economic recovery due to continued improvement in demand. Although the decline in household income amid the pandemic has forced consumers to tighten their spending, ecommerce and the widespread use of delivery services can help offset the decline in consumer spending.

Mr. Roces: With the expectation of a long pause in policy rates at low levels and some recovery in corporate earnings and economic activity, the environment would be more favorable to risky assets than risk-free. Our view is that any weaknesses in the market are an opportunity to increase exposure, especially in cyclical names that can leverage on the economic recovery.

Mr. Asuncion: Local equities will continue to dominate trading and the PSEi’s direction, although the macroeconomic backdrop may not be as upbeat relative to offshore market developments. Local vaccine news may provide positive gains including positive corporate earnings reports or those that will mimic [fourth quarter of 2020] GDP’s improvement.

Mr. Ricafort: Further rollout of COVID-19 vaccines worldwide and eventually in the country would help reduce new COVID-19 cases that would justify further reopening of the economy, such as easing Metro Manila’s GCQ (since June 2020) to MGCQ that allows increased capacity for many businesses/industries, as well as further easing of restrictions on public transportation, thereby could lead to higher production, sales, incomes/livelihood, and higher investment valuations.

Mr. Mapa: Equities will move sideways with bouts of rallies when GDP shows a headline grabbing growth prints by the second quarter. Market remains susceptible to sell-offs once investors realized that despite the façade of strong growth, economic activity remains well-below pre-pandemic levels.

Mr. Neri: The performance of local stocks will depend on the pace of the country’s recovery, the management of the pandemic, and subsequent rollout of the vaccines. If we’re able to avoid another lockdown, equities might stay within the 7,000-7,500 range.

FOREIGN EXCHANGE (FX) MARKET
BSP: Over the near term, the peso should continue to reflect emerging demand and supply conditions in the FX market as well as the continued soundness in the country’s macroeconomic fundamentals. Meanwhile, the impact of expected weaker inflows (i.e., decline in exports and tourism receipts) should be offset by favorable investor sentiment over the strong position of the economy, including in terms of sound debt management and adequate FX cover.

Mr. Roces: For FX, year to date, the PHP (Philippine peso) ranks eighth in the region and could be signaling a slowdown in its appreciation trajectory.

Mr. Asuncion: Regardless of what the BSP does, the balance of payments surplus outlook will stoke the PHP’s further strength. On the flipside, rising gross international reserves supports an upward push on the PHP further. BSP seems serious about maintaining the psychological P48-level no matter what. And since BSP has been committed to the prevailing record low interest rate setting and a lavish liquidity backdrop, keeping price stability may come in the guise of a stronger PHP that can imports further.

Mr. Ricafort: The peso exchange rate has been hovering among the strongest levels vs. the US dollar in more than four years at a little over P48, as supported by slower demand for imports amid softer demand in the economy since the COVID-19 pandemic, as well as relatively weaker US dollar vs. major global currencies among 2.5-year lows recently after US interest rates reached record lows near zero during the COVID-19 pandemic.

Mr. Mapa: PHP should remain supported in the near term as import demand is expected to remain soft in the coming months as economic activity stays well below pre-pandemic levels.

Mr. Neri: With the economy slowly reopening, we expect imports to recover further in the coming months in line with the expected improvement in local demand. Hence, dollar demand may pick up and the exchange rate may move closer to the 49 level. A risk to this outlook is government underspending, especially in infrastructure. With businesses still struggling, the lack of fiscal support and public construction may stall the recovery and dampen the demand for capital goods.