Strong fundamentals to lift financial markets; gov’t spending to support economic growth

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LOCAL financial markets performed well for the most part in the third quarter, buoyed by positive developments at home amid a slew of uncertainties abroad.

That period saw the peso appreciate against the US dollar by 3.37% on a year-on-year basis to average P51.74-per-dollar relative to the P53.54-per-dollar average in the third quarter of 2018. Traders that time attributed the peso’s appreciation largely to expectations of an interest rate cut by the US Federal Reserve.

“In the third quarter of 2019, favorable developments supported the positive performance of financial markets in the country such as the 1) benign inflation environment; 2) dovish outlook from the US Federal Reserve and the BSP; and 3) the easing trade tensions between the US and China,” said Bangko Sentral ng Pilipinas (BSP) Deputy Governor Francisco G. Dakila, Jr. in an e-mail to BusinessWorld.

These developments, he said, were able to offset the impact of the decelerating domestic GDP (gross domestic product) growth in the second quarter and “external headwinds” brought by the absence of a Brexit deal.

The US Fed cut interest rates for the first time in more than a decade in July and did so again at its subsequent policy meeting in September in what US Fed Chair Jerome Powell and some others have characterized as “insurance” against risks to the economy.

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US job growth increased moderately in September and the unemployment rate dropped to near a 50-year low, the US Labor department reported on Oct. 4, allaying concerns the economy is nearing recession.

Meanwhile, at home, the debt paper auctions conducted in the third quarter indicated strong demand. For instance, the Treasury-bill (T-bill) auctions conducted in July to September saw total subscription for the quarter amounting to around P333.04 billion, which is around 3.7 times the P90-billion aggregate offered amount.

Similarly, Treasury-bond (T-bond) auctions during the period had a total subscription amount of P370.5 billion, 2.6 times more than the offered amount of P140 billion.

In the secondary bond market, domestic yields on the benchmark 91-day T-bills and 10-year T-bonds were down by 135.8 bps and 27.1 bps, respectively, in end-September compared to end-June levels. Yields were down across the board, lower by 70.39 bps on average during the reference period, according to the PHP Bloomberg Valuation (BVAL) Service Reference Rates published on the Philippine Dealing System’s website.

“[T]he sustained deceleration of inflation as well as dovish pronouncements of the BSP helped drive the rally of the domestic GS market. RRP (reverse repurchase) cuts as well as reductions to the reserve requirement ratio (RRR) helped push yields lower while additional liquidity freed up by RRR infusions simply found their way to the fixed income market given the lack of any better alternatives,” ING Bank Senior Economist Nicholas Antonio T. Mapa.

For equities, the Philippine Stock Exchange index (PSEi) closed the July–September period at 7779.07, down by 2.8% compared to second quarter’s a mere one percent rise.

DOMESTIC ECONOMY REBOUNDS
Amid uncertainties abroad, positive developments at home had helped lift investor sentiment.

One such development, BSP’s Mr. Dakila pointed out, is the slowing inflation in the domestic economy. In the third quarter, inflation further decelerated to 1.7% from 3% in the second quarter. This brought the year-to-date average inflation to 2.8%, which is still within the government’s target of 2-4%.

In October, inflation eased to 0.9%, its slowest clip since the 0.7% observed in April 2016 amid lower food and electricity prices paired with base effects coming from last year’s nine-year high 6.7% inflation logged in September and October 2018.

“The latest inflation outturn is consistent with the BSP’s overall assessment that inflation has likely bottomed out in October and could start to pick up slightly in the remaining months of 2019 as base effects from 2018 will turn positive,” Mr. Dakila said.

Nevertheless, Mr. Dakila said the project gradual uptrend is “still consistent” with the central bank’s overall assessment of a “benign” outlook of inflation settling within the target range of 2-4% for 2019-2021.

“The country’s continued favorable macroeconomic performance is likely to support investor sentiment in financial markets for the remainder of 2019,” Mr. Dakila said, adding that higher government spending is “expected to provide support” to economic growth as well as contribute to positive investor sentiment.

The low inflation environment, coupled with disappointing economic growth figures in the first-half supported the BSP’s move to dial back last year’s rate hikes in the face of successive multi-year-high inflation rates. So far, the BSP has cut these rates by a cumulative 75 bps, two of them in the third quarter with reductions of 25 bps each on Aug. 8 and Sept. 26.

The next day, the BSP announced a 100-basis point reduction in RRR for universal and commercial banks to 15%, five percent for thrift and rural banks, and three percent for rural banks, respectively, to take effect “on the first day of the first reserve week of November.”

The quarter also saw the government catching up on spending. Budget department data showed the government having spent about 17% more at P1.04 trillion in the third quarter from P886.2 billion a year earlier, which is a marked improvement from the 2.3% contraction in the second quarter and 0.8% in the first quarter.

Moreover, infrastructure spending reached P234.8 billion in the third quarter, 7.7% more than the P218.1 billion recorded in July–September last year. A closer look at the data showed infrastructure and other capital outlays reaching P100.3 billion in September, picking up from August’s P59.3 billion and the P65.2 billion spent in September last year.

OUTLOOK
Economists expect the economy to fare better in the second half, and even more so considering its performance in the third quarter.

“On the domestic front, the speedbumps that caused the slowdown in growth are largely behind us with the government spending accelerating rapidly to chase their spending targets. Meanwhile, successive easing from the BSP may finally help resuscitate lending and capital formation going forward with GDP expected to recover,” said ING Bank’s Mr. Mapa.

“Meanwhile, other developments, such as decelerating inflation will likely reverse in the coming months as base effects wash out, limiting the potential rally for the GS market further,” he added.

For UnionBank of the Philippines, Inc. Chief Economist Ruben Carlo O. Asuncion, domestic markets will improve due to lower inflation, but noted “downside risks” to this outlook such as the ongoing US-China trade war and the oil price movements.

Security Bank Corp. chief economist Robert Dan J. Roces said that the driving factors in the third quarter such as the US Fed rate movements, developments in the US-China trade negotiations, Brexit, the BSP monetary easing, below-target inflation, and the rebound in GDP growth would continue to sway financial markets in the fourth quarter with “special emphases” on the possible phase one agreement between the US and China that would potentially lead to normalization of trade relations and the government’s timely release of the 2020 budget schedule.

Below are the outlooks for each of the key markets:

EQUITIES MARKET
BSP’s Mr. Dakila: “Encouraging reports on third-quarter domestic corporate earnings and better-than-expected third-quarter Philippine economic growth are likely to positively influence market sentiment. The improved outlook on the Philippine economy and low inflation environment can help buoy the equities market amid continued external headwinds.”

“For one, while import growth is set to recover as infrastructure spending picks up, export growth will likely remain lackluster as global growth continues to slow down. In addition, US-China trade reports, combined with the evolving path for Brexit, can contribute to market fluctuations in the short term.”

Rizal Commercial Banking Corp. (RCBC) Chief Economist Michael L. Ricafort: “Local equities could continue to gain in the fourth quarter of 2019 as relatively lower inflation and local interest rates (lower borrowing costs), as well as faster GDP growth, could further support faster growth in both sales and net income of Philippine companies, thereby justifying improvements in equity valuations and prices.”

“On external factors, improved global market risk appetite amid the possible partial trade deal between the US and China in November 2019–December 2019 and less uncertainties related to Brexit drove US stock markets to new record highs in November this year, thereby could support sentiment on the global stock markets and local as well.”

UnionBank’s Mr. Asuncion: “As the 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.”

ING Bank’s Mr. Mapa: “Equity market could benefit from reallocation as well as stronger growth figures to close out the year.”

Security Bank’s Mr. Roces: “Upward. Easing inflation, rate cut, lingering trade tension, after mostly consolidation in 2019.”

FIXED-INCOME MARKET
BSP’s Mr. Dakila: “Philippine bond market activity is expected to be influenced mainly by National Government issuance of government securities as part of its borrowing program. Meanwhile, corporations are likely to continue to tap the debt securities market to support their funding requirements. Corporate bond issuances from the first three quarters of 2019 stood at P376.3 trillion, 23% higher than total corporate bond issuances in 2018.”

“Bond market activity will also be supported by continuing efforts to further develop the Philippine capital markets. For example, the BSP issued Circular 983 that set a zero-percent reserve requirement ratio on repo transactions to encourage more players and enhance price discovery and liquidity in the market. This complements the decision of the Bureau of Internal Revenue to exempt repo transactions under the program from documentary stamp tax. These initiatives will reduce transaction costs for the repo market and encourage debt issuances by corporations.”

“Recent ratings and outlook upgrades are likewise expected to translate to lower borrowing costs from the international market for both the government and private corporations. In turn, this could translate further to cheaper financing options for the domestic market that could improve the country’s external position.”

RCBC’s Mr. Ricafort: “Philippine BVAL yields could remain steady/relatively low (some local bond yields still among two-year lows) amid relatively benign inflation environment and after the series of policy rate cuts that lowered borrowing costs and cuts on banks’ RRR that infused a total of about P440 billion in additional liquidity into the financial system that could support relatively low local borrowing costs, faster increase loan growth, faster growth in capital formation, and increased economic activities.”

“However, increased global market risk appetite could lead to some upward correction in benchmark bond yields in the US and other developed countries that could indirectly affect local bond yield benchmarks (partly reversing the risk aversion in the earlier part of the third quarter that resulted in new lows in the benchmark bond yields in the US and other developed countries).”

UnionBank’s Mr. Asuncion: “Lower interest rates tend to discourage investors to invest them in fixed-income securities like bonds. Yields might continue to move downward due to the recent RRP cut and the effectivity of RRR cut on December.”

ING Bank’s Mr. Mapa: “Likely correction to close out the year if liquidity conditions tighten and inflation accelerates.”

Security Bank’s Mr. Roces: “Upward. We think that downside to yields will be subdued as it seems that BSP has already carried out all planned easing measures for the years and as US yields continue to rise following risk-on sentiment. Will offer attractive yields against developed market and regional peers.”

FOREIGN EXCHANGE MARKET
BSP’s Mr. Dakila: “The peso’s movements in the near term will continue to reflect fundamental (long term) factors alongside temporary or short term factors that may affect local market sentiment. For its part, the BSP continues to adhere to its policy of allowing market forces to determine the level of the peso, which provides the following benefits: (i) a flexible peso is consistent with the BSP’s inflation targeting framework; and (ii) a flexible peso acts as an automatic stabilizer to restore macroeconomic balance for a small open economy like the Philippines.”

RCBC’s Mr. Ricafort: “Seasonal increase in OFW (overseas Filipino worker) remittances and conversion to pesos in the fourth quarter of 2019 partly due to some tuition payments and for Christmas-related spending could still support further gains in the peso exchange rate versus the US dollar as seen recently, with the peso among the strongest levels in 22 months at 50.00 levels recently.”

“On external factors, improved global market risk appetite amid positive developments on the US-China trade talks for a possible partial trade deal in November 2019-December 2019 could help improve sentiment on Emerging Market financial markets, including the Philippine financial markets.”

UnionBank’s Mr. Asuncion: “The peso will continue to depreciate as the market expects more positive signs from the US. Seasonal and intermittent strengthening periods are anticipated due to the inflows of personal remittances from overseas Filipinos, and service sectors (BPO and Tourism).”

ING Bank’s Mr. Mapa: “[The peso is] seen to enjoy short term strength, but eventually see marginal weakness on profit taking after carry trade thins out.”

Security Bank’s Mr. Roces: “Steady. Easing done by the US Fed may be the last for the year, offset by US-China trade jitters where a phase one agreement may happen late in the year or early next year. Also, slight depreciation expected due to upcoming (pre-announced) rate cuts and inflation rising back to 2-4% range. — Lourdes O. Pilar

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