By Lourdes O. Pilar, Researcher
UNCERTAINTY may once again be the theme for 2018 as developments at home and abroad in the first quarter sent local financial markets on a spin.
In the first quarter, the Philippines saw Republic Act No. 10963, or the Tax Reform for Acceleration and Inclusion Act (TRAIN) taking effect in January. The law, which was passed last December 2017, effectively reduced income taxes of almost all of the country’s taxpayers, but also levied additional taxes on products that include sugar-sweetened beverages, cigarettes, fuel and cars.
The passage of TRAIN was met with good news by the market, as they now anticipate higher government spending on infrastructure. The recently enacted tax reform is expected to fund 25% of the government’s P8.4-trillion infrastructure spending program.
This bullish sentiment showed in the stock market. In January, the Philippine Stock Exchange Index (PSEi) breached the 9,000-point mark, making nine record-highs in the month alone.
The euphoria, however, was short-lived as concerns over the faster-than-expected domestic inflation and perceived high stock valuations sent the index crashing below the 8,000-level. Adding to the volatility are the timing of interest rate hikes in the Philippines and the US as well as the looming trade tensions between the US and China.
“Amid concerns over the uptick in inflation and the economy overheating, most investors have remained on the sidelines in the local bourse…,” said Zeno Ronald R. Abenoja, senior director at the Bangko Sentral ng Pilipinas’ (BSP) Department of Economic Research.
Mr. Abenoja added that investors during the quarter were pricing in a rate hike by the BSP at its monetary policy meeting in May, of which the central bank eventually did.
The increase in May marked the BSP’s first tightening move in nearly four years, raising borrowing costs by 25 basis points (bps). At the new settings, rates now stood at 3.75% for the overnight lending rate, 3.25% for the overnight reverse repurchase rate, and 2.75% for the overnight deposit rate.
Prior to raising rates in May, the BSP kept policy rates unchanged during its February and March monetary board meetings although it announced a reduction of banks’ reserve requirement ratios by a percentage point starting March.
Jitters were also felt in the money and bond markets as the peso depreciated for much of the quarter while bond yields increased.
The same three months brought the value of the peso down with the currency averaging P51.43-to-a-dollar in the first quarter of 2018, according to BSP data. After starting the year at the P49-per-dollar level, the peso slipped to an 11-and-a-half-year low at P52.45-per-dollar in February. The peso’s performance in March rebounded somewhat, averaging P52.07-per-dollar.

The end of the first quarter brought the peso-dollar exchange rate to P52.16-per-dollar, depreciating by 4.28% during the period from December 2017’s closing rate of P49.93-per-dollar level.
“This is in contrast with the strengthening of most Asian currencies during the period,” the BSP noted in its quarterly inflation report with other exceptions being the Indian rupee, Indonesian rupiah, and the South Korean won.
Guian Angelo S. Dumalagan, market economist at the Land Bank of the Philippines (LANDBANK), said that the largely hawkish statements from the US Fed officials, the US-China trade war and “generally upbeat” US labor and employment reports “have weakened the local currency by igniting fears of four US rate hikes this year.”
The same sentiment was echoed by Michael L. Ricafort, economist at the Rizal Commercial Banking Corp. (RCBC): “Since the start of 2018, peso-to-dollar exchange rate has gone up already by about 4%, while other Asian currencies have ironically declined by 2-4%,” he said.
Meanwhile, in the local bond market, investor demand for government securities stayed robust based on oversubscriptions in the Bureau of Treasury’s auctions during the quarter. This reflected the market’s cautious sentiment amid the uncertainty in both the Philippine and US central bank’s direction on monetary policy.
For instance, the primary bond market saw average yields for the 91-, 182-, and 364-day Treasury bills (T-bills) in the three-month period increase to 2.637% (from 2.034% in the previous quarter); 2.813% (from 2.497%); and 3.088% (from 2.878%), respectively.
With the exception of the 6-year Treasury bond, yields for debt papers in the secondary market also increased relative to rates in the fourth quarter of 2017, with yields higher by a range of 4.3 bps for the 1-year T-bills to around 145.9 bps for the 20-year Treasury bonds compared to last year.
“Philippine bond yields followed the same trend as the dollar-peso exchange rate in that yields climbed initially before consolidating in March 2018… After rising in January and February, yields lost some momentum in March 2018 after the BSP affirmed the appropriateness of its policy settings, despite higher domestic inflation,” LANDBANK’s Mr. Dumalagan said.
MORE VOLATILITY AHEAD
Locally, inflation will continue to remain a downside risk for economic growth.
“[T]he BSP believes that a timely increase in the policy interest rate will help arrest potential second-round effects by tempering the buildup in inflation expectations. Moreover, the BSP observed that strong domestic demand allows some scope for a measured adjustment in the policy rate without adversely affecting the country’s economic growth momentum,” BSP’s Mr. Abenoja said.
Ruben Carlo O. Asuncion, chief economist at the Union Bank of the Philippines (UnionBank), concurred: “Upward pressure on inflation or price level will continue to persist due to TRAIN law effects and other supply-side issues. However, this is seen as transitory and temporary due to the structural changes implemented through TRAIN,” he said.
For LANDBANK’s Mr. Dumalagan, economic data on the Philippines and the US, especially that on inflation “warrants attention… since they may further fuel speculations of more tightening moves from either the BSP or the US Fed.”
Besides domestic inflation, BSP’s Mr. Abenoja said investors should also keep an eye on external developments, citing the protectionist policies by the US and China, the geopolitical tensions over Syria, and the pace of tightening by the US Federal Reserve.
The US and China have been imposing tariffs on each other’s goods since March, triggering fears of a looming trade war that has unsettled financial markets worldwide. Following the decision to impose higher rates on Chinese imports of aluminum and steel, China has responded with a $3 billion worth of tariffs on US fruits, nuts, pork and wine.
“While latest indications are that the Trump Administration is looking to negotiate with China on trade, the prospect of trade restrictions and counter-restrictions have undermined investor confidence and growth prospects,” Mr. Abenoja said of the US-China trade war, adding that an increasing preference towards protectionism by the US “would have painful ramifications for emerging markets.”
Meanwhile, he pointed out the volatility in other stock markets amid fears that the US Fed might quicken its pace of tightening to curb inflation.
“The surge in US jobs growth and wages in January pointed to quickening inflation during the early half of February. Mid-month, reports of a higher-than-expected 2.1% US inflation in January and the slightly hawkish tone of minutes of the January meeting, combined with rising US Treasury yields, prompted caution across global markets,” Mr. Abenoja said.
So what’s next for financial markets? Below are the forecasts made by the economists interviewed.
FIXED-INCOME SECURITIES
BSP’s Mr. Abenoja: “[B]ond prices are expected by the market to fall, on continued expectation of faster policy rate hike adjustments by the US Fed. The Fed has forecasted as much as four rate hikes for 2018 on the account of strengthening economic activity in the US. Consequently, capital flow reversal could dampen investments in fixed-securities in the Philippines.”
LANDBANK’s Mr. Dumalagan: “Yields are expected to rise continuously in response to higher inflation and rate hike expectations. For this reason, fixed income securities may register wider mark-to-market losses. There might be heavier demand for shorter-dated notes, as these securities are less price sensitive to rising interest rates.”
Jose Mario I. Cuyegkeng, ING Bank senior economist: “We expect the market to recover once inflation slows and as government slows financing. But near term consolidation is likely in the meantime until cues over inflation and government financing needs turn more favorable in third or fourth quarters.”
RCBC’s Mr. Ricafort: “Upward trend in yields [is] still intact (could still go up), [which is] partly a function of local inflation (recently at new 5-year highs) and how US government bond yields fare as a function of future Fed rate hikes.”
UnionBank’s Mr. Asuncion: “The upward pressure on yields is mainly due to inflation expectations by the market. The level of prices is expected to remain elevated in the coming months until about all of the first half of 2018 and will consequently keep upward pressure on yields.”
EQUITIES
BSP’s Mr. Abenoja: “While the BSP remains optimistic that headline inflation will settle to average within the target range in the last quarter of 2018 (and moderate further in 2019), the continued uncertainty about trade policies and geopolitical tensions overseas is expected to continue to cast a shadow over the equities market and keep investors on edge. Moreover, the PSE has also recently announced its withdrawal from its initial plan to integrate the equities market with fixed income exchange that would have boosted sentiments with the launch of new products and services.
“Moving forward, the market is expected to continue to consolidate amidst lingering geopolitical and trade tensions abroad, and in the absence of fresh leads or new catalysts. Positive earnings of listed firms and higher economic growth for the first-quarter could provide the market a much needed boost.”
LANDBANK’s Mr. Dumalagan: “Equities are expected to remain volatile in 2018, even as they might bounce back towards the end of the year amid prospects of an infrastructure-led growth. Geopolitical concerns and shifting rate hike views would drive volatility, although expectations of stronger domestic economic activity would provide an overall upward momentum in the latter part of the year.”
ING’s Mr. Cuyegkeng: “Recent weakness open up good value for investors. If our view of slowing inflation and lower market rates is realized during the year, there is reason to expect a recovery in the local equity market.”
UnionBank’s Mr. Asuncion: “A recovery is expected in a short amount of time. [The] higher-than-expected inflation and weaker peso are not enough reasons to cause a bear market.”
PESO-DOLLAR EXCHANGE RATE
BSP’s Mr. Abenoja: “Over the policy horizon, the peso is expected to be supported by good macroeconomic fundamentals. The expected growth in foreign exchange inflows from overseas Filipino remittances and business process outsourcing revenues (in 2018 by 4% and 10%, respectively); and sustained inflows from foreign investments, tourism receipts, as well as the ample level of the country’s gross international reserves, are expected to support the peso.
“Likewise, business and investor confidence, as reflected in the recent Fitch Ratings’ upgrade of the Philippines’ investment grade score to ‘BBB,’ should continue to provide stability to the peso.”
LANDBANK’s Mr. Dumalagan: “The dollar-peso exchange rate is expected to remain volatile this year due to geopolitical concerns and changing rate hike expectations. While the peso may remain weak until mid-year, it could recover towards the end of 2018, as the government’s aggressive infrastructure spending starts to exert a stronger boost to economic growth, complementing the impact of the recent cut in personal income taxes.”
ING’s Mr. Cuyegkeng: “Moderate weakness before modest strengthening by the end of the year is likely. The underlying US dollar demand from imports for a domestically driven economy remains strong…”
RCBC’s Mr. Ricafort: “[The foreign exchange will be around the] P51- to P52-per-dollar levels, up vs. P49.93 in end-2017, as the peso exchange rate is partly a function of the trade deficit data. Relatively wider trade deficits compared to recent years have led to higher US dollar/peso exchange rate in recent months.”
UnionBank’s Mr. Asuncion: “The downward pressure on the peso is expected to continue as import demand increases due to increasing investments, both public and private ones.”

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