By Marissa Mae M. Ramos
ECONOMISTS expect financial markets in the second half to bounce back from the challenging first half amid anticipations of further accommodative monetary policy that would stimulate the economy even as risks remain such as the ongoing trade tensions and the uncertain global economic growth.
“In [the second quarter of 2019], financial markets were primarily weighed down by developments in the world economy. However, these developments were more than offset by favorable domestic factors, resulting in an overall improvement in the performance of domestic financial markets,” Bangko Sentral ng Pilipinas (BSP) Deputy Governor Francisco G. Dakila, Jr. said in an e-mail to BusinessWorld.
In particular, Mr. Dakila noted the ongoing US-China trade tensions as well as weak external demand amid the slowdown in major economies, citing the April 2019 issue of the International Monetary Fund’s (IMF) World Economic Outlook report wherein IMF downgraded its global growth forecasts by 0.2 percentage point in 2019 compared to its estimate at the start of the year.
For ING Bank NV Manila Senior Economist Nicholas Antonio T. Mapa, external factors that affected financial markets during the quarter were the aforementioned trade war and the “disposition of the [US Federal Reserve] with regard to rate adjustments.”
“Initially, there was heightened concerns about trade with the US and China trading barbs and tariffs, which eventually dovetailed to a capitulation on the Fed with regard to policy direction. The subsequent reversal in outlook by the Fed, induced in large part by the festering trade spat, brings us now to the situation where the Fed will not just pause with rate hikes but rather cut rates altogether, sparking risk on tone in [emerging markets],” Mr. Mapa said.
The US Fed kept policy rates unchanged in its June 18–19 meeting, but dropped its patient rhetoric on monetary policy, saying it would “act as appropriate” to keep the economy growing amid trade tensions abroad and global growth slowdown. The Fed has likewise hinted possible rate cuts before yearend, with the US central bank cutting policy rates early this month by 25 bps, the first time in a decade.
At home, similar developments arose with markets widely expecting the BSP to cut policy rates due to easing price pressures and a disappointing first-quarter economic growth.
Domestic inflation averaged 3.4% in the first half, past the midpoint of the BSP’s 2-4% target range for the year though still above the revised 2.7% full-year forecast average. The quarter saw inflation rate at 2.7% in June, the slowest in two years. Meanwhile, inflation in May picked up, albeit slightly to 3.2% from a 16-month low three percent in April.
The second quarter also saw the government reporting a 5.6% gross domestic product (GDP) growth in the first three months of the year, its lowest in four years or since the first quarter of 2015. The first-quarter turnout, which economists largely blame on the almost four-month delay in the passage of this year’s national budget, snapped the economy’s growth streak of sixteen quarters when it registered at least six percent growth.
Hours after the release of first-quarter GDP data, the BSP reduced borrowing costs by 25 basis points (bps) in May, its first rate cut since a cumulative 175-bp hike last year amid multi-year high monthly inflation rates. A few weeks later saw the BSP announcing a cut in the reserve requirement ratio (RRR) of rural and cooperative banks by 100 bps to four percent from five percent, as well as a series of 200-bp RRR cuts in universal and commercial banks (to 16% from 18%) and rural banks (to 6% from 8%).
The market expected the central bank to trim interest rates by 25 bps in its August 8 meeting, despite a “prudent pause” in its June 20 policy review.
In addition to loosening monetary policy, investors have “reacted positively” to Standard & Poor’s credit rating upgrade to “BBB+” and Fitch Rating’s affirmation of the country’s “BBB” sovereign credit rating during the quarter, according to BSP’s Mr. Dakila. These developments, he said, supported the Philippine Stock Exchange index (PSEi) and the appreciation of the peso during the period.
The bellwether PSEi traded sideways as it closed the second quarter at 7,999.71, up almost one percent from the first quarter.
Meanwhile, gains were made in the money and bond markets as the peso appreciated during the quarter while bond yields declined.
The same three months brought the value of the peso up with the currency averaging P52.07-to-a-dollar versus the P52.37-per-dollar average from the previous quarter.
As of end-June, yields on government securities (GS) declined on average by 85 bps relative to the end-March levels, according to the PHP Bloomberg Valuation Service Reference Rates published on the Philippine Dealing System’s website. During the quarter, GS debt yields were lower by a range of 53.3 bps for the 10-year tenor to 133.9 bps for the three-month Treasury bills.
Notwithstanding the developments in the first half, economists expect the economy to fare better in the second half.
“Weaker global economic prospects amid a possible easing in global demand and continued uncertainty over trade tensions between the US and China are likely to continue to weigh down on financial markets for the rest of the year,” BSP’s Mr. Dakila said.
“However, a favorable inflation environment and relatively strong domestic recovery have brought positive developments in the markets, helping guide expectations towards a stable outlook for the rest of the year,” the BSP official added.
Inflation may even decelerate under two percent in September given base effects, according to Bank of the Philippine Islands (BPI) lead economist Emilio S. Neri, Jr. However, he cautioned of the possibility of the headline rate bouncing back around three to four percent level after favorable base effects fade.
Mr. Neri also saw the 6-7% economic growth target “challenging” following the “subpar performance” in the first semester.
On the other hand, ING Bank’s Mr. Mapa has likened the Philippine growth narrative to a “tale of two halves,” with the Philippine economy on a “speed bump” in the first half before finishing strong in the second half.
“I think the [Philippine economy] can finish the year on a high note with growth seen to average 6.4% as the economy can look to the complete growth package of household spending (given low inflation), government spending (2019 budget passed), and capital formation (BSP rate cuts) to come to the fore to lift growth back into the six-percent handle and help the Philippine economy achieve escape velocity from the current five-percent level of growth…,” Mr. Mapa said.
Security Bank Corp. chief economist Robert Dan J. Roces shared a similar assessment: “[The Philippine] economic performance in the second half rests on government spending, better capital formation, and rebound in private consumption.”
“Deficits in the [current account] will likely weigh down growth if this is not addressed. And with the trade war slowly evolving into a currency war and will probably drag on, global growth will remain subdued,” he added.
For Sun Life Financial economist Patrick M. Ella, most of the factors that will drive growth are “largely external” such as developments in the US-China trade war, the geopolitics that influence global oil prices, and regional tensions stemming from territorial claims with China among others.
“If any of these worsen, it can easily shift investor sentiment and see a net outflow of investments that impact national output,” Mr. Ella said.
“Domestically, the market will definitely watch how government spending will perform after the first-quarter budget delay and, of course, the follow-through on ‘Build, Build, Build,’ which is on its fourth year already…,” he added.
The following are the outlook for each of the key markets:
ING Bank’s Mr. Mapa: “Positive given expectations for faster growth as the economy chases escape velocity.”
Sun Life Financial’s Mr. Ella: “Earnings is key here. We expect a good [second-quarter] earnings report versus [that in the first-quarter].”
Michael L. Ricafort, economist at Rizal Commercial Banking Corp. (RCBC): “Sustained easing trend in inflation and interest rates have helped increase the profitability of listed companies in terms of lower prices of various inputs as well as lower financing/interest rate costs, thereby leading to higher net incomes and higher valuations for some listed companies.”
“The declining trend in US and global interest rates, with benchmark bond yields/interest rates in developed countries even at new record lows… would lead some investors to search for higher returns in the stock/equity markets, especially some stock issues with higher dividend yields (alongside prospects of stock price appreciation) compared to bonds/fixed income instruments, thereby could provide some support to the equities market as some global funds search for higher returns in emerging markets such as the Philippines…”
Ruben Carlo O. Asuncion, chief economist at Union Bank of the Philippines, Inc.: “If inflation continues to ease, a recovery in equities market is expected. The market will be advanced by the strong earnings of domestic companies and the strength of foreign corporations.”
Security Bank’s Mr. Roces: “Equities will continue to sustain its upward momentum in [third quarter of 2019], as lower interest rates trickle down into the economy sectors that would most benefit would be property, banking and consumer companies.”
“Further monetary easing and acceleration in government spending should help corporates deliver higher earnings growth in the second half of 2019. However, global growth slowdown and trade war concerns may provide headwinds in the near-term.”
BPI’s Mr. Neri: “Trade uncertainties, lower growth in the first half of the year, and the ghost month may prevent the PSEi from rising substantially in the near term. However, we remain optimistic on the long term performance of the local stock market given the strong fundamentals of the economy, supported by robust earnings performance and improving valuations.”
BSP’s Mr. Dakila: “The Philippine bond market is expected to be influenced mainly by issuances of government securities. It is further expected that the government will continue to favor domestic borrowings over foreign sources to limit the country’s exposure to foreign exchange risks. Meanwhile, some corporations might tap the debt securities market to support their funding requirements. This may be limited as we remain a bank-centric economy where it is easier and less costly to avail bank financing than to issue bonds.”
ING Bank’s Mr. Mapa: “Positive given the trough of inflation for 2019 and the likely additional easing from the central bank.”
Sun Life Financial’s Mr. Ella: “Some rally in rates are still possible in the [third quarter], especially if the BSP will be more aggressive than a 25 bps per policy meeting decision.”
RCBC’s Mr. Ricafort: “Hefty price gains (correspondingly sharp easing in local benchmark yields) have already been seen in recent weeks… Further price gains [are] still possible (or corresponding further easing on local yields)… especially if US/global bond yields continue to go down amid the lingering US-China trade war that further slow down global economic growth, global oil prices, and, global inflation.”
“Recent tensions on Iran also led to some flight-to-quality or shift to the safest global havens such as the US Treasuries.”
UnionBank’s Mr. Asuncion: “High interest rates tend to encourage investors to invest them in fixed-income securities like bonds. The upward pressure on yields is mainly due to inflation which consequently keeps upward pressure on yields.”
Security Bank’s Mr. Roces: “A sustained easing trend in inflation, the just-announced 25 bps cut in local policy rates, and a telegraphed 100 bps cut in RRR will likely lead to lower yields. Short-end rates are seen to fall driven by the normalization in deposit rates while the drop in long term yields will be driven by the inflation outlook.”
BPI’s Mr. Neri: “The yield curve may normalize (i.e., steepen) as a result of the expected improvement in liquidity in the coming months. Short-term rates may decline further close to the policy rate of the BSP. The yield curve has been flat for many months because of tight liquidity, but additional liquidity from the policy rate and reserve requirement ratio cuts done by the BSP may pull down short term yields.”
“However, additional decline in the long end of the curve may be marginal since inflation may gradually rise after October. Furthermore, a possible recovery in corporate loan demand may trigger profit taking in the GS market that could push yields higher as banks would need the funds for lending.”
FOREIGN EXCHANGE MARKET
BSP’s Mr. Dakila: “Over the next few months, the peso’s performance can be influenced by external developments that may affect local market sentiment. These include shift towards protectionism, a faster-than-expected monetary policy normalization in the US, weak demand and low inflation in advanced economies, as well as geopolitical concerns.
ING Bank’s Mr. Mapa: “Appreciation on foreign flows given the dovish Fed, but gains to be tempered on FX demand for accelerating imports.”
Sun Life Financial’s Mr. Ella: “It’s possible to see a stronger level for the peso at this point. I would not rule out a [P49-to-a-dollar level]. While [third quarter] typically sees corporate demand for imports which tends to weaken the peso, we should bear in mind that the search for yields by global investors has placed [Philippine government securities] as one of the better Asian treasury securities out there. Plus the very real possibility of seeing the Philippines gain an A-rating for its credit in the next 18-24 months… that should mean [local government] securities are in demand thus keeping peso strength.”
RCBC’s Mr. Ricafort: “Any further cuts in Fed Fund Rates could be possible especially if the US-China trade war escalates, which further slows down the global economy/outlook and global inflation, thereby increasing the odds of additional Fed rate cuts going forward, which partly reduce the interest rate returns of the US dollar versus major global currencies, assuming all other factors are the same.”
UnionBank’s Mr. Asuncion: “The peso will continue to depreciate due to this huge infrastructure development. Seasonal and intermittent strengthening periods are anticipated due to the inflows of personal remittances from overseas Filipinos, and service sectors.”
Security Bank’s Mr. Roces: “We expect the peso to settle to around [P52.250-to-a-dollar] by end [of third quarter]. Potential risks are in trade uncertainties and sell-offs, although we have ample cover from the [gross international reserves] due to a record buildup in reserves.”
BPI’s Mr. Neri: “The Peso may continue to weaken against the Dollar in the medium term as the country’s trade deficit is likely to remain elevated, with additional depreciation pressure coming from global uncertainties such as the US and China trade conflict. The depreciation of the Peso is a result of the expansion of the trade deficit, as the country is spending on much needed infrastructure.”