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The Cost of Federalism

Outlook. Global geopolitical and local political noise put investors on the defensive and will keep the yield curve elevated in the near-term. Ongoing discussions about a shift to federalism is getting more traction, but economists and analysts are warning about the ill-effects of the shift to the economy. Fiscal deficit to GDP ratio is estimated to reach 6% or more after another Php44-72bn needed for the shift, according to Socioeconomic Planning Secretary Ernesto Pernia, and might risk hyperinflation or a downgrade of the Philippines’ credit rating if done hastily. Overseas, the trade battle between the U.S. and China worsened after the Trump administration threatened to impose 10% tariffs on $200bn of Chinese products ranging from clothing to furniture. The latest tariff threat came just days after the U.S. levied tariffs on $34bn of Chinese-made machinery and electronics on July 6, on top of scheduled tariffs on $16bn of Chinese electronics and other components. Coupled with overshooting inflation and a behind-the-curve Bangko Sentral (BSP) policy rate, there are too many unknown variables in play that could sideline bond market investors. The highlights of the monetary board meeting last June 21 will be released on Thursday and will shed more light on the BSP’s stance.

Market review. The local benchmark yield curve rose by 5bps week-on-week (WoW) on average and up by 95bps YTD amid a defensive market. The spread between the local 10-yr local benchmark and the 10-yr US Treasury (UST) widened to 362bps last week from 353bps as the former rose by 9bps to 6.45% (done), while the latter was also higher by 1bp WoW to 2.83%. Yields of ROPs also fell by an average of 6bps, bucking the movement of the UST curve which was 2bps higher on average last week.

Average total daily traded volume down 24% week-on-week (WoW) to Php6.3bn. The liquid yield curve rose by an average of 10bps WoW on thin trading. The front-end (364-day T-bill) rose by 7bps to 4.63%, the belly (FXTN 10-61: 9.7yrs) increased by 8bps to 6.41%, while the tail (R25-01: 20.5yr) likewise rose by 19bps to 7.29%. Secondary trading average volume fell by 24% to Php6.3bn, dragged by T-bond volume which fell by 35% to Php3.9bn. On the other hand, T-bill trading rose by 6% to Php2.4bn. Last week, the Bureau of the Treasury’s (BTr) latest Php15bn auction of 91-day, 182-day and 364-day T-bill was partially awarded. The BTr fully-awarded the 91-day with an average rates of 3.291%, lower than the last auction, while the 182-day and 364-day were only partially awarded with accepted bids capped at an average of 4.185% and 4.767%, respectively, both higher than the previous auction. The auction was almost twice oversubscribed at 1.88 bid-to-cover ratio. Lastly, the Php15bn auction of reissued 7-yr bonds was completely rejected as bids submitted were significantly higher than the previous auction and secondary market rates. The auction was also undersubscribed at 0.93 bid-to-cover ratio.

Emerging Markets’ (EM) 10-year unchanged (WoW). Yields of EM bonds we follow were unchanged WoW on average amid renewed trade tensions between the US and China. Brazil (10-year yield -16bps), Indonesia (-12bps), and Peru (-11bps) outperformed last week, while Turkey (10-year yield +57bps), Colombia (+1bp), and Mexico (-3bps) relatively underperformed.

USTs up 2bps WoW. US Treasuries rose by 2bps WoW on average, while the 10-yr UST was flat, just up by 1bp WoW to 2.83%, following the report of a 2.9% YoY increase in consumer prices in the twelve months through June, offsetting the 2.7% increase in average hourly wages in the same month. This was the highest increase in six years. The impact of ongoing trade disputes was evident in producer prices, which rose by 0.3% last June from 0.5% in May. On an annualized basis, producer prices rose by 3.4%, the highest in seven years, driven by increased costs for metals used in construction and manufacturing, suggesting that the steel and aluminum tariffs recently put in place by the Trump administration are driving up input costs. Recall that US core personal consumption expenditure (PCE) index hit 2% last May, the first time it hit the Fed’s target. Headline PCE rose by 2.3% from 2.0% in April. The data did not move the needle on Fed hike expectations as most analysts still expect at least one more rate hike before the end of the year, but consumer sentiment as measured by a survey by the University of Michigan indicated that there is a growing concern regarding inflation amongst Americans.

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