Financial markets take breather in Q4, but headwinds remain

By Mark T. Amoguis, Assistant Research Head

THE FOURTH QUARTER of 2019 saw local financial markets performing relatively sideways with positive factors at home such as the inflation slowdown and catch-up government spending partly cushioning the impact brought by developments abroad.

In the fourth quarter, the peso average P51.03 against the dollar, appreciating 1.39% from the previous quarter’s average of P51.74:$1, BSP data showed. Likewise, the local unit appreciated by 4.38% compared to the P53.26-to-a-dollar average seen in the fourth quarter of 2018.

Meanwhile, at home, the debt paper auctions conducted in the fourth quarter indicated strong demand. Treasury-bill (T-bill) auctions conducted in October to December saw total subscription for the quarter amounting to around P234.503 billion, which is around 2.3 times the P100-billion aggregate offered amount.

Similarly, Treasury-bond (T-bond) auctions during the period had a total subscription amount of P287.848 billion, 2.4 times more than the offered amount of P120 billion.

In the secondary bond market, domestic yields were lower by a range of 2.1 bps for the 182-day T-bill to 42 bps for the 5-year T-bonds compared to end-September 2019 levels. On the other hand, yields rose for the 91-day (10.2 bps), 20-year (13.7 bps), and 25-year (22.8 bps) debt papers. On average, yields were lower by 18.72 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 bellwether Philippine Stock Exchange index closed the fourth quarter at 7,815.26, up by 0.5% compared to the third quarter’s 2.8% decline.

“On the external front, performance of Philippine financial markets were weighed down largely by negative sentiment stemming from the following: (1) the pro-democracy unrest in Hong Kong; (2) conflicting signals about the US-China trade talks; (3) fears that China’s economic slowdown will spillover to its neighboring countries; and (4) the impeachment case of President [Donald J.] Trump,” the Bangko Sentral ng Pilipinas’ (BSP) Deputy Governor Francisco G. Dakila, Jr. said in an e-mail.

Back home, domestic factors such as the “favorable” inflation print and the uptick in economic growth in the final three months last year “partly tempered the external headwinds,” Mr. Dakila added.

Much of the talk regarding a “phase one” trade deal between the US and China began on October last year. The deal, which was signed on Jan. 15, took effect on Feb. 14, marking the first time of easing sanctions following the nearly-two years of trade war between the world’s two economic superpowers. The deal involved the halving of tariffs on goods imposed by the US and China as well as addressing some US complaints about intellectual property practices.

The phase two of the trade deal is still under negotiations.

The quarter also saw central banks implementing cuts on their key policy rates, including the US Federal Reserve, which slashed its federal funds rate by 25 bps on end-October.

The BSP decided to maintain key interest rates during the quarter, but implemented a 200-bp reduction in cumulative reserve requirement ratios that took effect in November and December.

INFLATION TO EDGE HIGHER IN 2020
(BUT WITHIN EXPECTATIONS)
Last year saw headline inflation clocking in at a three-year-low of 2.5%, within the central bank’s 2–4% target band for the year. Economists, however, noted that this would pick up this year.

“While inflation has started to pick up after bottoming out in October 2019, latest baseline forecasts indicate that inflation could settle firmly within the government’s target range of [2–4%] and is expected to settle close to the midpoint of the target by 2020–2021,” BSP’s Mr. Dakila said.

“Inflation is projected to gradually approach the midpoint of the target range in [the first quarter of 2020] as base effects from lower food prices during the same period in 2019 start to dissipate,” the official added.

ING Bank NV Manila Senior Economist Nicholas Antonio T. Mapa shared this assessment, as inflation “has nowhere to go but up.”

“With reverse base effects kicking in after the abnormally low inflation path in 2019, we can expect inflation to be nudged higher on average. The first quarter could see inflation experience an uptick due to supply disruptions caused by the Taal Volcano eruption before seeing only marginal increases in inflation for the second quarter. The third quarter, however, will see inflation trend higher on reverse base effects (third quarter 2019 was the low point in last year’s path) kick in before fourth-quarter inflation settles down to bring full year average to about 3.2%,” he said in an e-mail.

For Sun Life Financial Economist Patrick M. Ella: “We expect inflation for first quarter to be within the upper 2% to lower 3% range while our full-year 2020 view is at present 3%, but this can change as we approach the first half of 2020,” he said.

Bank of the Philippine Islands Lead Economist Emilio S. Neri, Jr. said inflation “may climb back to the 3-4% level” in 2020.

“We continue to see favorable base effects from rice, still a result of rice tariffication. However, most of this may disappear in the second quarter and rice prices may normalize. The ongoing drought and rice supply problems in Thailand and Vietnam may lead to higher rice prices in the coming months. Meanwhile, global oil prices declined recently as markets considered the potential impact of the coronavirus on global oil demand. However, oil prices may bounce back quickly once the coronavirus crisis is resolved. Hence, our average inflation forecast for 2020 is 3.4%,” Mr. Neri said.

Meanwhile, UnionBank of the Philippines, Inc. Economic Research Officer Katrina Joy C. Javier said inflation is expected to remain within 2-4% in the first three months of the year.

“Upward pressure in January was brought by the US-Iran tension on global oil prices, Taal Volcano eruption and African Swine Flu, but these events will likely dissipate. Moreover, aggressive government spending for the extended 2019 budget will also be an upward pressure in inflation for the rest of the year, but this will be eased by the decline in global oil prices and Meralco rates,” said Ms. Javier.

OUTLOOK
At home, analysts point to the contribution of government and private investment spending as key drivers to the domestic growth this year as the Philippine economy finished strong last year.

To recall, the country’s gross domestic product (GDP) expanded by 6.4% in the final three months of 2019 after it grew by 5.8% in the first three quarters. Much of the drag was due to the disappointing growth rates of 5.6% and 5.5% in the first two quarters of last year with analysts blaming the nearly four-month delay in the approval of the 2019 national budget which left new projects unfunded and stymied government spending.

Despite an 18.7% growth in government spending in the fourth quarter, the economy failed to hit the already-trimmed 6-6.5% target as it posted an eight-year low of 5.8%. Dragging growth was capital formation, which recorded a 0.4% growth rate in the fourth quarter and a 0.6% decline in 2019 — a turnaround from its expansion of 13% in 2018.

The government sought to address this by swiftly passing the P4.1-trillion national budget for 2020 as well as extending the validity of the P3.6-trillion 2019 budget by a year.

“This sort-of ‘dual stimulus’ may act as double insulation from the continuing and anticipated global economic and trade growth uncertainties,” said UnionBank’s Ms. Javier.

For Sun Life’s Mr. Ella: “We want to see how government spending will impact on growth as the current budget and the unused portion of last year’s budget should (as market expects) deliver a rather strong showing,” he said.

“Another is if private investments will do a rebound this year as the proposed CITIRA (Corporate Income Tax and Incentives Rationalization Act) bill will likely be passed within the first quarter… which takes off a lot of uncertainty to the investment framework in the country,” he added.

The CITIRA bill proposes to gradually cut corporate income tax to 20% from 30% over 10 years, while removing redundant fiscal incentives.

BPI’s Mr. Neri said that investment spending may recover on the back of low interest rates and the recovery in the public spending.

“The fundamentals of the economy still provide the necessary conditions for investment spending as corporates need to expand their operations through the build-up of fixed assets to meet the rising demand from consumers. However, achieving higher growth in 2020 mostly depends on the ability of the government to spend on infrastructure,” Mr. Neri explained.

For ING’s Mr. Mapa, the COVID-19 will likely dictate much of the sentiment early this year as the impact to the global economy will likely be felt later in the year: “The importance of China cannot be stressed more in this regard and losing one of the biggest cogs in the global value chain for an extended period of time will weigh on global growth and tourism,” Mr. Mapa said.

The coronavirus outbreak was first reported in Wuhan province, China. As of Feb. 11, it recorded more than 44,000+ cases and killed more than a thousand people in China alone. The virus has spread to more than 20 countries including the Philippines.

This led several institutions to trim their growth forecasts this year amid disruptions in global supply chains. For the Philippines, government estimates pointed to an economic impact ranging from 0.06% to as much as 0.7% off GDP growth.

“With the country’s substantial exposure to China, the virus may also exert economic pain on the Philippines. In particular, exports to China/Hong Kong and tourism may struggle in the coming months,” Mr. Neri said.

With these developments, below are the analysts’ outlooks for each of the key markets:

FIXED INCOME
BSP’s Mr. Dakila: “Philippine bond market activity will be influenced mainly by national government issuance of government securities as part of its borrowing plan… Meanwhile, corporate bond issuances are expected to continue to expand, fueled by the revised rules for bond issuance implemented since 2018 and the improved liquidity conditions and benign inflation environment.”

BPI’s Mr. Neri: “The yield curve may steepen this year, as upward pressure on the long end of the curve could come from higher inflation and greater supply of private and public sector issued bonds.”

Sun Life’s Mr. Ella: “We are bullish on rates, we expect another policy rate cut (of 25 bps) by mid-year and 200 bps cut in RRR (reserve requirement ratio) this year.”

ING’s Mr. Mapa: “Rally early on before reversing as government crowding out kicks in.”

UnionBank’s Ms. Javier: “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 RRP (overnight reverse repurchase benchmark interest rate) and RRR cuts.”

EQUITIES
BSP’s Mr. Dakila: “Investors expect the equities markets to perform better in the first quarter of 2020 as a result of positive sentiment due mainly to the country’s sound macroeconomic fundamentals. However, uncertainty over the extension of Manila Water and Maynilad’s water concession from 2022 to 2037 could also weigh down on sentiment. Moreover, geopolitical tensions abroad (i.e. conflict between US and Iran) could negatively affect the local bourse…”

BPI’s Mr. Neri: “The possibility of higher economic growth in 2020 may provide the support that equities need to advance. However, uncertainties from several issues like the coronavirus outbreak may temper gains.”

Sun Life’s Mr. Ella: “[Equities] could advance this year but still hampered by sentiment.”

ING’s Mr. Mapa: “[Equities] still weighed down early but reverse into rally as government negotiations yield fruitful with concessionaries and with CITIRA clarity attracting foreign inflows.”

UnionBank’s Ms. Javier: “As the inflation continues to be stable, 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.”

FOREIGN EXCHANGE
BSP’s Mr. Dakila: “The peso’s movement in the near term will continue to reflect fundamental (long term) factors alongside temporary or short-term factors that may affect local market sentiment…”

BPI’s Mr. Neri: “With the possibility of a wider current account deficit from the recovery in public sector capital spending, the fundamentals still point to a depreciation trend for the peso in the medium term. While USD/PHP market is closer to the 51 level at present, we expect a return to the 52–53 level in 2020, reflecting the recovery of public sector spending.”

Sun Life’s Mr. Ella: “Our view is 50–51 by year-end.”

ING’s Mr. Mapa: “Gradual depreciation trend on import demand but foreign investment flows to slow depreciation trend.”

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