Weekly Fixed Income Summary : July 16 – 20, 2018

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Fifty Basis Point-Hike Likely

Outlook. Affirmation of the Philippines’ credit rating and outlook from Moody’s, Fitch, and S&P provided a brief respite for bond investors after weeks of local and global economic and geopolitical uncertainty. Both Moody’s and Fitch maintained the country’s BBB/Baa2 rating - a notch above investment grade - while maintaining a stable outlook. Meanwhile, S&P upgraded its outlook from stable to positive for the country, citing the country’s economy’s overall strength. All agencies flagged risks from higher inflation and the possible shift to federalism.

Minutes from the monetary board meeting last June 21 were released last week and strongly hinted at a hike in August 9, the next monetary board meeting. BSP Governor Espenilla reiterated the same sentiment, saying that the BSP is ““considering strong follow-through monetary adjustment at the next meeting of the Monetary Board in August”, the magnitude of which will be dependent on relevant economic data, especially inflation. After exceeding all expectations last June, inflation is expected to peak during the third quarter after the effects of transportation fare hikes and increase in electricity rates set in, coupled by a spike in food prices amid seasonally bad weather. According to Espenilla, the gradual unwinding of accommodative monetary policy in the US would likely continue and drive fund flows away from EMs like the Philippines, while geopolitical tensions between the US, China, and some key oil producing countries could drive second quarter inflation higher. While expectations of a BSP hike this August mount (some even expect a 50-bp hike), we expect yields to gradually rise to price in these expectations.

Market review. The local benchmark yield curve fell by 2bps week-on-week (WoW) on average and up by 93bps YTD ahead of the President’s state of the nation address (SONA), with bond prices driven by the rating agencies’ affirmation of the Philippines’ fiscal health. The spread between the local 10-yr local benchmark and the 10-yr US Treasury (UST) narrowed to 351bps from 362bps in the prior week as the former fell by 5bps to 6.40% (done), while the latter was higher by 6bps WoW to 2.89%. Yields of ROPs also fell by an average of 4bps, bucking the movement of the UST curve which was 4bps higher on average last week.

Average total daily traded volume up 23% week-on-week (WoW) to Php7.8bn. The liquid yield curve fell by an average of 3bps WoW amid a slight uptick in trading volume. The front-end (364-day T-bill) rose by 7bps to 4.70%, the belly (FXTN 10-61: 9.7yrs) fell by 5bps to 6.36%, while the tail (R25-01: 20.5yr) rose by 4bps to 7.33%. Secondary trading average volume increased by 23% to Php7.8bn, driven by a 69% increase in T-bill volume to Php4.1bn. On the other hand, T-bond trading was flat, down by 5% to Php3.7bn, reflecting a more defensive market. Last week, 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. On the other hand, the latest Php15bn auction of 91-day, 182-day and 364-day T-bills was fully-awarded as demand was healthy in the short end of the curve. Average T-bill rates settled at 3.219%, 4.235%, and 4.809%, and the auction was 2.2x oversubscribed.

Emerging Markets’ (EM) 10-year down 2bps (WoW). Yields of EM bonds we follow were down by 2bps WoW on average amid huge swings last week due in part to contrasting comments by Trump and Fed officials. Turkey (10-year yield -76bps), Brazil (-23bps), and Mexico (-8bps) outperformed last week, while Indonesia (10-year yield +39bps), Pakistan (+23bps), and Russia (+20bps) underperformed.

USTs up 2bps WoW. US Treasuries rose by 4bps WoW on average, while the 10-yr UST was up by 6bp WoW to 2.89%, despite Trump calling out the Fed’s hikes on Twitter. The market, instead, sided with Fed Chair Powell’s reiteration to stay the course of gradual hikes. Odds for a 50-bp hike by December rose to 59% by the week’s end from 53%. The market largely shrugged off Trump’s rhetoric with Iranian leaders (with the former threatening to Tehran with severe consequences if it makes more threats towards the US), but instead turned its attention towards Japan. Reports emerged that the Bank of Japan (BoJ) is holding preliminary discussions on making policy adjustments, with a focus on ways to make the massive stimulus program more sustainable. The BoJ has been gradually reducing its bond buying since September 2016 - when it set a policy target of 0% in the 10-year bond yield. The bank’s next monetary policy meeting is scheduled for next week, July 31.

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