Weekly Fixed Income Summary : March 26 – 28, 2018

Inflation, TRAIN-2 Put Upward Pressure on Yields

Outlook. We expect upward pressure on bond yields to persist, especially given (1) Bangko Sentral’s (BSP) recent release of its March inflation expectation of 3.8%-4.6% (based on 2012 index), markedly higher than February’s 3.9%; and (2) news that the Lower House’s version of the second tax reform package is revenue-eroding, at least for the next two years as the House Bill proposes that reduction of fiscal incentives begin only 2 years after the bill is implemented. This may lead to more borrowing than initially expected to fund the government’s infrastructure program. Bond issuances are already starting to ramp up, with borrowing in the second quarter expected to grow by 35% quarter-on-quarter (QoQ) to Php325bn ($6.2bn), pressuring up interest rates. The debt auctions will also be more frequent, from fortnightly to weekly. Inflation rates in the next few months will remain crucial to either justify the BSP’s decision to maintain or hike rates, the latter to ease pressure on the peso. If the March CPI print rises above 3.5%, we could see bidders demanding wider spreads in bond auctions and a wary secondary market at least until the next BSP Monetary Board meeting and the first quarter GDP growth rate, both due mid-May.

Market review. The benchmark yield curve rose by an average of 2bps week-on-week (WoW) on a shortened and light trading week. The spread between the local 10-yr local benchmark and the 10-yr US Treasury (UST) widened to 323bps from 315bps, as the former rose by 3bps to 6.00% (done) and 30bps year-to-date (YTD), while the latter shed 5bps to 2.77%. Yields of ROPs fell by an average of 5bps, tracking the movement in USTs, which fell slightly by 1bp.

Total daily traded volume down 26% week-on-week (WoW) to Php7.4bn. The liquid yield curve rose by an average of 9bps amid the shortened work week. Higher inflation expectations once again hit the bond market, and although the BSP noted that inflation won’t breach the 5% mark, investors would rather err on the side of caution. The front-end (FXTN 05-72: 1yr) rose by 2bps to 2.93%, the belly (FXTN 10-61: 9.7yrs) down by 33bps to 5.88%, while the tail (R25-01: 20.5yr) shed 3bps to 7.16%. Secondary trading volume fell by 26% to Php7.4bn, as T-bond trading almost halved to Php4.9bn, slightly offset by T-bill trading volume that almost tripled to Php2.5bn. Still these volumes are on the low side. The Bureau of the Treasury (BTr) partially awarded its Php5bn 91-day T-bill auction last Monday (April 2) while completely rejecting all the bids for the 182-day and 364-day auction. Average bids for the 91-day bill was capped at 3.191%, raising a total of Php3.27bn. The entire auction was undersubscribed, with tenders only totalling Php13.6bn of the Php15bn offered. On the other hand, the Php10bn auction for reissued 3-yr bonds was fully awarded, fetching an average bid rate of 4.632% and was twice oversubscribed.

Emerging Markets’ (EM) 10-year yields down 3bps week-on-week (WoW). Yields of EM bonds we follow were down by 3bps WoW on average despite China’s decision to slap retaliatory tariffs this early on U.S. pork and wine. Indonesia (10-year yield: -11bps), Brazil (-8bps), and the Philippines (-3bps)outperformed last week, while Turkey (10-year yield +5bps), Chile (-2bps), and Mexico (-2bps) relatively underperformed.

USTs down by 1bp WoW. US Treasuries fell by an average of 1bp WoW, while the 10-yr UST shed 5bps to 2.77% as volatility in stocks caused investors to seek haven in the UST market. Trade war fears also slightly abated, at least temporarily, as investors were encouraged by China’s decision partial tariff that excluded U.S. soybeans and commercial aircraft. Talks between Chinese and U.S. officials on opening the Chinese market to U.S. goods and protecting U.S. firms’ intellectual property rights were also encouraging. However, there is smoke again on news that the Trump administration was considering a crackdown in Chinese investments in U.S. firms with technologies deemed necessary to national security. Read full article here.