Stubborn inflation, high borrowing cost dampened markets in Q3

HIGH INFLATION, expensive borrowing costs continued to affect local financial markets in the third quarter, signaling volatility to persist for the rest of the year.

The barometer Philippine Stock Exchange index (PSEi) finished the July-to-September period at 6,321.24, dipped by 2.3% quarter on quarter from 6,468.07 at the end of the second quarter.

Annually, the index went up by 10.1% from the 5,741.07 finish in the third quarter of 2022.

On the other hand, data by Bankers Association of the Philippines showed the peso closed P56.575 against the greenback in the third quarter, weakening by 2.4% from the second quarter finish of P55.20 to a dollar.

Year on year, the local unit strengthened by 3.6% from P58.63 finish in the same quarter last year.

The demand for Treasury bills (T-bills) auction subscription totaled P654.9 billion with a cumulative P182.6 billion offered amount in the third quarter. This was higher than the P416.6 billion subscription with P157.4 billion offered amount in the previous quarter.

The amount of oversubscription at P384.8 billion was also higher than the second quarter’s P259.2 billion.

Meanwhile, the demand for Treasury bonds (T-bonds) saw a total of P642.2 billion, lower than the P687.2 billion in the April-to-June period. Despite the decline, the demand for T-bonds in the third quarter period was higher than the aggregate offered amount of P279.7 billion.

Domestic yields at the secondary bond market inched up by 0.90 basis points (bps) on average quarter on quarter, based on the PHP Bloomberg Valuation (BVAL) Service Reference Rates published on the Philippine Dealing System’s website.

On an annual basis, yields grew on average by 18.38 bps.

Analysts attributed the local financial market developments for the third quarter to global factors of rising borrowing costs, stubborn inflation, and geopolitical conflict.

The third quarter of the year saw rate pauses as the US central banks pause key monetary policies at 5.255.5%, the highest level in two decades.

Borrowing costs were raised by 500 bps by the US Federal Reserve since March 2022 to combat inflation.

The Bangko Sentral ng Pilipinas (BSP) also kept its key rate at 6.25% between May to September this year. Since May 2022, policy rate hikes had reached a total of 450 bps to tame inflation.

But headline inflation quickened to 6.1%, the highest since the 6.6% recorded in April.

However, in an off-cycle meeting in October, the central bank lifted its policy rates by 25 bps. Target reverse repurchase (RRP) rate was raised to 6.5%. Interest rates for the overnight deposit and lending facilities were also kept at 6% and 7%, respectively.

October inflation eased to 4.9% and further cooled to 4.1% in November, a 20-month low.

Security Bank Corp. Chief Economist Robert Dan J. Roces said in an e-mail that the local financial market in the third quarter was influenced by stubborn inflation and high borrowing costs.

China Banking Corp. (China Bank) Chief Economist Domini S. Velasquez said that “these two factors led to higher government security yields, weaker peso, and outflows from the local bourse.”

“Amid export restrictions, extreme weather conditions and fare hikes, domestic inflation remained on the upside for the first two months of the quarter,” Metrobank Research said in an e-mail.

BSP said in an e-mail interview that by the end of the [third] quarter, widening debt spreads and rising domestic and global inflation fueled “a higher-for-longer interest rate environment.”

INDICATORS TO WATCH OUT FOR

Volatility is likely to persist in the local financial markets in the near term, said Mr. Roces.

For Ms. Velasquez, the financial market will be relatively stable for the rest of the year given that “central banks have reached their peak policy rates.”

“Looking ahead, the outlook for the local financial markets remains cautious [with] inflation [still] a key concern for policymakers while elevated interest rates are a challenge to businesses,” Mr. Roces said.

Similarly, the BSP said that it “[deems] it appropriate to keep an elevated target RRP Rate for the time being until inflation expectations are better anchored and a downtrend in inflation becomes evident.”

Mr. Roces adds that although inflation may have slowed in October, further rate hikes by the BSP are still dependent on several factors, namely: inflation data, global economic developments, domestic shock due to adverse weather, and the previous Barangay and Sangguniang Kabataan (SK) elections which should increase government spending, he said.

He also expects geopolitical conflict between Israel and Palestine to be an influencing factor to look out for.

“The ongoing conflict between Israel and Palestine has the potential to disrupt global energy supplies and contribute to rising oil prices if it turns regional. This could directly impact the local financial markets by putting upward pressure on inflation,” Mr. Roces said.

On the other hand, Metrobank Research said that the conflict should not influence the local financial market in the coming months as it is still mainly a regional conflict.

“The risk of an escalation has recently receded, and there are talks already of a truce and an exchange of hostages,” it said.

“The effects of the Israel-Hamas conflict on the financial markets and economy remain manageable, for as long as the conflict does not escalate and spread to other countries in the Middle East,” Rizal Commercial Banking Corp. (RCBC) Chief Economist Michael L. Ricafort said in an e-mail.

“[The conflict’s] effect to financial markets is quite small. We saw this at the start of the war, where financial markets reacted with risk-off sentiment the day after but corrected immediately,” Ms. Velasquez adds.

On the upside, Mr. Ricafort sees a boost in the economy for the last quarter of the year as the gross domestic product (GDP) print picks up amidst increased government spending and easing global prices as of October.

He expects the Philippine economy to grow around 5.5%6% in 2023.

In the July-to-September period, the country’s GDP posted a 5.9% annual growth, an improvement from the 4.3% in the second quarter. This brought the country’s year-to-date GDP growth to 5.5%, falling short of the 6-7% growth target by end-2023.

RATE HIKE PAUSES

“For the coming months, US and local inflation is moving closer to central bank targets and would justify at least a pause in Fed and local policy rates later in 2023,” RCBC’s Mr. Ricafort said.

Strong economic performance in the easing trend of inflation in October, four-month low prices of oil, and strong peso-dollar exchange rate are among the factors cited by Mr. Roces to warrant a pause in rate hikes.

“With local inflation likely staying above-target in the near term, an additional hike remains to be a risk although the baseline view is still a long pause followed by cuts,” the Metrobank Research said.

For near-term, it expects electricity rates and minimum wage adjustments outside the National Capital Region to be upside risks to inflation.

Meanwhile, Metrobank Research sees rate pauses for both local and US central banks since “another Fed rate hike would cause a sell-off in the US treasury bonds space.”

Similarly, Ms. Velasquez said that she expects the BSP to pause rate hikes, but a hawkish sentiment may remain with risks and inflation still “tilted to the upside.”

Security Bank’s Mr. Roces, on the other hand, said that “the Fed’s commitment to keeping interest rates ‘higher for longer’ and the possibility of a further rate hike by the end of the year could put renewed pressure on the local markets in the coming months.”