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Trade War Fears

Outlook. Upward pressure on yields on the release of rising inflation. February inflation clocked in at 4.5%, a 3-yr high and higher than the Department of Finance’s (DoF) 4.1% estimate, January’s 4.0%, but in line with both the Bangko Sentral’s (BSP) estiamte of 4.0%-4.8% and consensus expectation of at least 4.5%, driven by the food and non-alcoholic beverages index at 4.8% and the double-digit growth in alcoholic beverages and tobacco index at 16.9%. Local inflation has now breached the BSP’s target band of 2%-4% in 2 consecutive months. BSP Governor Espenilla noted that the spike in inflation is just transitory and that inflation remains manageable. However, Deputy Governor Guinigundo also noted that this does not mean that a hike is not completely off the table either.

The BSP also noted that it will now be releasing inflation figures on a 2012 rebased index together with the 2006 based index. In the rebasing, February inflation was at 3.9% while January inflation was 3.4%. Espenilla noted that the BSP expects inflation to normalize back to the target band in 2019 due to high-base effect this year, whether it be based in 2006 or 2012. The rebasing was to reflect the changes in the regular Filipino’s consuming habits.

Market review. The benchmark yield curve rose by an average of 27bps week-on-week (WoW) on higher inflation expectations. The spread between the local 10-yr local benchmark and the 10-yr US Treasury (UST) slightly narrowed to 393bps from 398bps, as the former shed 6bps to 6.79% while the latter fell by 2bps to 2.86% but is seen to approach 3%, ahead of the anticipated Fed hike this month. Yields of ROPs rose by an average of 6bps, tracking movements in USTs.

Liquid yield curve slightly flattening. Total daily traded volume up 48% week-on-week (WoW) to Php9.1bn. The liquid yield curve rose by an average of 1bp, almost unchanged WoW, but the belly to the tail end of the curve shed 5bps on average while the front end rose by an average of 9bps, ending the week with a yield curve that is somehow flatter WoW. The front-end (FXTN 05-72: 1yr) was up by 12bps to 3.02%, the belly (FXTN 10-61: 9.7yrs) down another 8.5bps to 5.77%, while the tail (R25-01: 20.5yr) was up by 47bps to 7.03%. Secondary trading volume crept up to Php9.1bn, up 48% WoW, as T-bill trading picked up, almost tripling to Php2.5bn (up 186%) while T-bond trading likewise rose by 25% to Php6.5bn. The Bureau of the Treasury (BTr) partially awarded its Php20bn auction of 5-yr bonds, which fed an average bid rate of 5.452%. The BTr capped the highest bid rate at 5.600% and awarded Php12bn as investors sought higher yields amid local inflation risks. The auction had a bid-to-cover ratio 1.3x. Lastly, the BTr fully rejected all Php21.3bn worth of bids for its Php20bn T-bill auction on higher-than-expected bid rates.

Emerging Markets’ (EM) 10-year yields up 2bps week-on-week (WoW). Yields of EM bonds we follow were up 2bps WoW on average on global trade risks spurred by Trump’s trade war declaration, starting with imposing import tariffs on aluminum and other steel. Poland (10-year yield: -16bps), Brazil (-15bps), and Hong Kong (-12bps) have outperformed last week, while Colombia (10-year yield: +43bps), South Africa (+16bps), and Hungary (+14bps) underperformed.

USTs up by 1bp WoW on average on Trump’s trade war talk. US Treasuries rose by an average of 1bp WoW, while the 10-yr UST fell slightly by 2bps to 2.86%, amid Trump’s pronouncements of a trade war and higher interest rate expectations in the market. Fed Chair Jerome Powell said that he and fellow policymakers were “going to be taking the developments since the December meeting into account and writing down our new rate paths”, which some interpreted to imply that recent strong economic and inflation data would prompt the Fed to raise rates four times in 2018 versus the three hikes previously expected. Powell somehow abated fears during his senate banking committee speech by taking on a more dovish tone, but New York Fed Dudley offset this by saying that four hikes is still ‘gradual’.

Trade friction spurred by Trump’s proclamations and consequent imposition of aluminum and steel tariffs further fueled fears of retaliation by other major economies and will feed into US inflation. Trump also threatened to slap tariffs on European cars. European Commission President Jean-Claude Juncker fired back, announcing plans to raise tariffs on imports of U.S. whiskey, motorcycles, and jeans, further sending markets into a tailspin. Odds for a Fed hike this month rose to 90% from 83%.

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First Metro Weekly Fixed Income Summary 2018 March 02

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