Weekly Fixed Income Summary : August 27 – August 31, 2018

Peaking Inflation

Outlook. There is significant upward pressure on bond yields as inflation expectations peak this quarter and concerns of further escalation of US-China trade dispute. The Bangko Sentral (BSP) expects inflation to hit 5.9% last August and cited a range of 5.5%-6.2%, which would be the highest this year and in a decade and would bring the year-to-date average to 4.6%. Consensus estimate amongst analysts is slightly higher at 6.0%. The BSP cited higher prices of rice and key food items due to weather disturbances and supply disruptions, an increase in gasoline and LPG prices, and a slight upward adjustment in electricity rates contributed to upward price pressures in August. Analysts expect at least one more 25-bp hike before the end of the year, though there are some who believe that the BSP might hold off on hiking this September especially following the 50-bp hike last August that would take some time to take effect in the overall economy. The next hike will most likely happen in the fourth quarter to temper price pressures amidst a period of seasonally high spending activity. As a result, inflation is expected to moderate in the fourth quarter also on base effect as inflation started trending north of 3% in the last quarter last year. This comes at a time of sustained rapid credit growth, as bank lending accelerated to 18.7% in July and tighter liquidity, with M3 last July clocking in at 11.0% from 11.8% in June. August inflation will be reported on Wednesday, September 5.

Market review. The local benchmark yield curve dipped by 16bps on average week-on-week (WoW) as the market grew weary of US-China trade war escalation. The spread between the local 10-yr local benchmark and the 10-yr US Treasury (UST) narrowed to 351bps from 391bps in the prior week as the former fell by 36bps to 6.37% (done), while the latter was up by 4bps WoW to 2.86%. Yields of ROPs rose by 3bps on average, tracking the movement of the UST curve which rose by the same amount.

Average total daily traded down 16% week-on-week (WoW) to Php7.7bn. The liquid yield curve fell by an average of 8bps WoW as the front-end (364-day T-bill) rose by 3bps to 4.86%, the belly (FXTN 10-61: 9.7yrs) down by 18bps to 6.44%, while the tail (R25-01: 20.5yr) was flat at 7.24%, just up 2bps WoW, amid escalating trade war concerns and growing consensus of a non-action by the BSP in September. Secondary trading average volume fell by 16% to Php7.7bn as both T-bond and T-bill volume shed 18% and 10%, respectively. The Bureau of the Treasury (BTr) fully-awarded Php15bn worth of reissued 3-yr T-bond last week amid strong market demand (1.8x oversubscribed). The auction fetched an average rate of 5.136%, slightly above the secondary market rate. Lastly, the latest Php15bn auction of 91-day, 182-day and 364-day T-bill was fully awarded at average bid rates of 3.225%, 4.101%, and 4.899%, respectively, 1bp, 3bps, and 3bps higher, respectively, than the previous auction. The auction was 1.8x oversubscribed.

Emerging Markets’ (EM) 10-year up 14bps (WoW). Yields of EM bonds we follow were up by 14bps WoW as Turkey’s higher than expected August inflation of 18% fueled fears that Turkey is on the verge of financial and economic crisis. The Philippines (10-year yield -36bps), Chile (-17bps), and Turkey (-17bps) outperformed last week, while Argentina (10-year yield +217bps), Brazil (+28bps), and Indonesia (+26bps) underperformed.

USTs up 3bps WoW. US Treasuries were up by 3bps WoW on average, while the 10-yr UST rose by 4bps WoW to 2.87%, on light trading ahead of the deadline on Friday of a new NAFTA trade deal amid escalating US-China trade relations. The beginning of the week seemed to start out right, with the Chinese government’s attempt to prop up the yuan via a new monetary policy. The move was interpreted as a good-willed gesture toward the U.S. as the cheaper yuan has made Chinese goods cheaper in the U.S. market while making U.S. goods less competitive in China. However, Trump turned it around on Thursday with his criticism of China’s foreign exchange policy and threatened a new round of tariffs on additional $200bn worth of goods. A flight to safe haven assets seemed to be in sight again as 1) Turkey’s central bank Deputy Governor Erkan Kilimci has reportedly resigned, which added to the gloomy sentiment about the country; and as 2) Argentina’s central bank raised its benchmark interest rate by 15% to 60%, sending the peso down 20%.