Inflation, El Niño, geopolitical tensions impacted markets in Q1

By Karis Kasarinlan Paolo D. Mendoza

A MIXTURE of inflation, El Niño, and geopolitical tensions continued to rock the financial markets in the first quarter while analysts expect borrowing costs to come down in the latter half of the year.

The Philippine Stock Exchange index (PSEi) — the barometer for the country’s stock market — closed the first quarter at 6,903.53, up 6.2% from 6,499.68 in the same period last year. The index was also up 7% from 6,450.04 in the October-December 2023 period.

Meanwhile, data from the Bankers Association of the Philippines showed the peso closed at P56.24 to the dollar in the first quarter, weakening by 1.6% and 3.5% from the fourth and first quarters of last year, respectively.

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According to the Bangko Sentral ng Pilipinas (BSP), the peso weakened in the first two months of the year due to higher market expectations of US Federal Reserve’s monetary policy continuing restrictions following higher-than-expected US inflation and strong labor data.

“Concerns over potential escalation of geopolitical conflicts in the Middle East and in the West Philippine Sea also had an impact on market sentiment. Nonetheless, the peso recovered in March amid signals from the US Fed on the timing of its monetary policy easing cycle possibly in the latter half of the year,” the BSP said.

The demand for Treasury bills (T-bills) reached P551.49 billion with offered T-bills reaching P202.3 billion in the first quarter. Demand was higher than P443.8 billion in the same quarter in 2023, and P300.51 billion in the final quarter of last year.

The oversubscription amount reached P349.19 billion, nearly twice last quarter’s P188.22 billion.

Treasury bonds jumped to P1.07 trillion from P461.69 billion in the previous quarter.

At the secondary market, domestic yields rose by 24.23 basis points (bps) on average quarter-on-quarter based on the PHP Bloomberg Valuation (BVAL) Service Reference Rates published on the Philippine Dealing System’s website.

On an annual basis, yields were also up by 12.38 bps.

Alvin Joseph A. Arogo, economist at Philippine National Bank (PNB), said in an e-mail that expectations of easing interest rates led to “mostly favorable movements” in the local financial markets in the January-to-March period.

In January, former Finance Secretary Benjamin E. Diokno said the central bank may reduce borrowing costs by up to 100 bps if inflation settles within the BSP’s 2-4% target.

Inflation fell within the BSP’s target of 2-4%, averaging 3.5% as of end-May.

The BSP has kept its policy rate steady at 6.5%.

However, other analysts said that headwinds such as geopolitical tensions, global inflation, and El Niño dampened markets in the first quarter.

Ruben Carlo O. Asuncion, chief economist at Union Bank of the Philippines (UnionBank), said in an e-mail that tensions between Russia and Ukraine and Israel and Palestine caused an increase in oil and energy prices, negatively impacting financial markets.

“The war in Ukraine and potential conflicts in the Mideast ramped up risk aversion and disrupted global economic growth,” Security Bank Corp. Chief Economist Robert Dan J. Roces likewise said in a separate e-mail interview.

“Rising inflation in major economies notably the US and a sentiment pivot by the US Federal Reserve on the back of mixed economic data triggered capital flight from emerging markets like the Philippines,” he added.

The Fed kept its policy rate at 5.25-5.5% on May 1, waiting for “greater confidence” in easing inflation before cutting rates, Reuters reported.

High commodity prices such as that of oil and food further spurred domestic inflation, Mr. Roces said.

On the other hand, Michael L. Ricafort, chief economist at Rizal Commercial Banking Corp., sees possible rate cuts despite geopolitical tensions.

“Global crude oil prices still hovered among two-year lows or since January 2022 despite the increased geopolitical tensions between Israel and Iran. That could still help US and local inflation to ease further, thereby supporting possible cuts in Fed and local policy rates later in 2024,” he said.

“At a local lens, the Philippine markets were affected as the agriculture industry faced the firsthand effects of El Niño. With lower crop yields and higher production costs, companies that are reliant towards agriculture resulted in price increases,” Mr. Asuncion said.

The effect of El Niño is expected to persist until May, causing agricultural produce to continue increasing in prices.

“[El Niño] is also expected to affect the foreign exchange markets. Since the Philippines heavily relies on exporting agricultural goods, the country’s trade balance and currency value will be negatively affected,” Mr. Asuncion said.

INDICATORS TO WATCH OUT FOR
Mr. Roces said that easing geopolitical tensions or a slowdown in global inflation could bode well for market performance, but continued headwinds could lead to volatility.

He also noted that Philippine economic data and the BSP’s monetary policy decisions are key factors to watch out for.

Analysts also said that Fed rate cuts should be monitored closely, as the Fed could be matched locally by the BSP later in the year.

“The outlook for US monetary policy continues to be a significant factor for emerging markets and thus may exert some pressure on domestic financial markets. In particular, expected delays in the US Fed’s policy easing cycle have fortified risk-off sentiment among market participants, which may indicate increased safe-haven trade and continued broad US dollar strength,” the BSP said.

Analysts said that the BSP will also consider inflation, economic growth, and exchange rate stability before cutting rates.

“If inflation shows a sustained downward trend and settles within the target range 2-4%, a rate cut becomes more likely. Continued economic growth without inflationary pressures would support a rate cut, and a stable peso is crucial to avoid imported inflation and potential capital outflows,” Mr. Roces said.

The central bank likewise said that its priority is to ensure that inflation will consistently be within its target before it starts its monetary easing cycle.

“The BSP deems it appropriate to keep monetary policy settings sufficiently tight in the near term to ensure that inflation reverts back to target inflation path before shifting to an accommodative policy stance,” it said.

“Since inflation continues to persist, there will be an increase in the yield on fixed income securities, leading to capital losses for bondholders,” Mr. Asuncion said.

PNB’s Mr. Arogo sees interest rate at 6% by end-2024 as they expect inflation to settle within the BSP’s 2-4% target starting September.

“In our view, however, the BSP should not cut rates ahead of the Fed or else risk further exchange rate weakness. If the Fed eases by 25 bps each on September and December, the BSP could follow in October and December,” Mr. Arogo said.

He expects markets to remain volatile in the second quarter due to uncertainty of the timing and magnitude of rate cuts amid fluctuations in inflation.

Mr. Asuncion expects seasonal effects to remain a factor in the second quarter and throughout the year as La Niña may develop in July or August this year. He added that the unpredictably of the climate may negatively impact sectors such as agriculture, construction, and tourism.

“In line with La Niña, there is a risk of flooding and landslides which will lead to delays or increased government spending in the construction of public works and destroyed crops from floodings leading to an increase in the production cost and the price of agricultural produce. In this case, investors will be keen on potential fluctuations in the market, to anticipate potential upward spikes in these commodities,” he said.

The BSP also said that supply-induced inflationary pressures stemming from adverse weather conditions may shift expectations and lead to further second-round effects.

On the upside, domestic factors such as economic growth prospects as well as growth in remittances and foreign direct investments are expected to help markets, it said.

FOREIGN EXCHANGE (FX) MARKET
Mr. Asuncion: The monthly USD-PHP exchange rate has been moving within the 55.88-56.03 range on average. However, in the beginning of [the second quarter], this increased to an average of 56.99 for April. For the remainder of [the second quarter], exchange rates are expected to face an increase, especially for the month of May, as the Philippines experiences negative implications from external factors such as US monetary policy, extreme heat from El Niño, increasing geopolitical tensions, etc.

Mr. Roces: The peso faces depreciation pressure due to potential global capital outflows and a stronger US dollar.

Mr. Ricafort: Improved US/global market risk appetite that could support sentiment on Emerging Markets, such as the Philippines, after US stock markets again posted new record highs. It is important to note that the US dollar-peso exchange rate already posted a bigger increase compared to most ASEAN currencies since the start of 2024 and since the Russia-Ukraine conflict started on Feb. 22, 2022.

EQUITIES MARKET
Mr. Asuncion: PSEi index closed at 6,646, 6,945, and 6,904. As for [the second quarter], the month of April ended with a close of 6,700. With historical data and Autoregressive Integrated Moving Average (ARIMA) models, we have forecasted the remaining months to have a close of 6,733 and 6,765 for May and June, respectively. Evidently, decreasing by a substantial amount when compared to Q1 index. This, however, is set to recover as we forecast a close of 6,962 by the end of 2024.

Mr. Ricafort: The local stock market gauge, the PSEi, corrected lower recently, at 6,607.22 after higher-for-longer signals from most Fed officials recently that partly reduced the odds of Fed rate cuts. Mostly higher net income of local listed companies recently that could support valuations. Seven-month support is at 6,360, which helps keep intact the underlying upward trend/momentum over the past seven months or since October 2023.

BSP: External developments including uncertainty in the timing of the US Fed’s monetary policy easing cycle due to delayed US inflation progress, subdued global economic growth prospects amid the elevated interest rate environment, as well as geopolitical concerns in the Middle East are expected to influence movements in domestic financial markets in the remainder of the second quarter. Other factors affecting market sentiment, such as the increasing upside risks to domestic inflation, as well as lingering geopolitical tensions in the West Philippine Sea will likewise continue to influence market movements.

FIXED-INCOME MARKET
Mr. Asuncion: Fixed-income inflation during [the first quarter] headlined at 2.77%, 3.4%, and 3.7%. In [the second quarter], the headline for inflation in April was 3.8%. Based on historical data ARIMA models, we have projected that May and June will have inflation headline values of 3.97% and 4.47%, respectively, for the coming months. Since inflation continues to persist, there will be an increase in the yield on fixed-income securities, leading to capital losses for bondholders.

Mr. Roces: If the BSP maintains current interest rates, fixed-income yields could rise, making existing bonds less attractive. However, new bond issuances with higher yields could be appealing to investors.

Mr. Ricafort: PHP BVAL yields mostly corrected lower since May 2024: Long-term PHP BVAL yields mostly among one-month lows, with the 10-year tenor at 6.7%. Further local policy rate pauses or cut (especially in 2024) could already be possible for the coming months, as fundamentally supported by the easing inflation trend as seen recently amid higher base/denominator effects; also, as a function of future Fed rate pause or cut. n