A perfect storm for the Philippine peso

Despite the peso appearing oversold a few weeks ago, the local currency has continued to weaken against the US dollar. It seems it’s only a matter of time before the peso will breach the all-time exchange rate high of PHP 56.45 to the dollar in March 2004. From there, it’s uncharted territory.

As discussed in my previous article, the main driver of the abrupt peso weakness has been the stark difference in the path of US interest rates compared to that of peso interest rates. Since late May, global markets have been pricing in a faster pace of increase in US interest rates, and, naturally, as the rate of return in a currency rises relative to others, the more attractive that currency becomes.

Fast forward to mid-July and what was already an incredibly fast pace of rate hikes in the US by historical standards has sped up even more after the higher-than-expected inflation print in June of 9.1%. Take a second to digest that: over 9 percent inflation.

The US Federal Reserve has made it clear that they are willing to do everything to cool inflation down, but this latest data point suggests that what they’ve done so far (and what they’re saying they’ll do) hasn’t been enough. This means that the Fed has no other choice but to carry on raising rates until its effects translate into stabilizing prices.

Rising inflation, rising rates

The market is worried, however, that if inflation keeps surprising on the upside, then US rates will need to continue rising higher and sooner. This level of worry has reached a point that even the Banko Sentral ng Pilipinas’ surprise off-cycle rate hike of 75 basis points (bps) on July 14, an attempt to stem the slide of the peso, was effectively shrugged off.

The Monetary Board’s next rate policy setting meeting is scheduled for August 18, and based on recent memory, it has revised its benchmark policy rates outside of the official meeting only once, back in March 2020 at the very onset of the COVID-19 pandemic to support the banking system and prevent panic setting in the economy.

The 75-bp hike is also much higher than what the BSP had been saying (i.e., 25 bps or 50 bps hike) for the August 18 meeting. In other words, this decision was a major tectonic-level shift in the BSP policy, and it was designed to shock and awe the forex market. It didn’t have the desired effect.

Confluence of factors

It seems the peso is caught in a perfect storm—a jittery global market that views any sign of a more aggressive US rate hike as enough reason to sell risk. This includes emerging market currencies (i.e., flight to safety) and peak import season in the Philippines, which means the third quarter seasonally sees the strongest level of demand for the US dollar. It also includes a widening current account deficit driven by rising coal and food prices, most of which are imported and hence priced in US dollars.

The BSP has not been alone in having to adjust its interest rate policies, with central banks in both developing and advanced economies forced to keep pace with the US Fed to defend their respective currencies. The euro has experienced one of the deepest currency depreciations year-to-date, which explains in part the European Central Bank’s (ECB) guidance for a 25 bps hike on July 21st.

Follow the leader: Many countries are keeping up with the US with regard to setting policy rates in order to protect their own currencies. 

Except for Brazil, most currencies have depreciated against the US dollar.

What now?

Despite this cloudy outlook for the peso in the near-term, the BSP’s unexpected move from “dovish” (i.e., keep rates lower for longer to support growth first) to “hawkish” (i.e., defend the peso to avoid importing more inflation) should at the least help slow the depreciation of the peso against the US dollar. Given the more defensive stand on the peso, the BSP may also re-activate previous actions of supplying US dollars to create a “more orderly” foreign exchange spot market.

The fiscal side of the government, led by the Department of Finance, can also help by attracting more foreign capital into the market, and hence increasing the supply of dollars via direct investments. It begins with preserving the investment grade rating of Philippine sovereign bonds, which involves clearly laying out policies that would target a lower fiscal deficit and hence less government borrowing while supporting the country’s productivity, i.e., continuing the infrastructure build-out. While these may be aspirations in the medium-term, sending the right signals to the market will still help.

High inflation never lasts long

Ultimately, the fate of the peso still rests on what the US Fed will do, which in turn will be dictated by signs that inflation in the US is peaking. These signs remain elusive, but as John Authers, a columnist from Bloomberg, wrote in his recent article, “it is the nature of things for inflationary peaks to be over swiftly and followed by sharp declines. History, going back more than a century, shows that inflation never stays as high as it is now for more than a matter of months (outside of wars and the 1970s stagflation)”.

In the meantime, we still see any drop in the peso-dollar exchange rate below PHP 56 as a chance to buy, even though it is much higher than it used to be.

RUBEN ZAMORA is First Vice-President and Head of Institutional Investors Coverage Division, Financial Markets Sector, at Metrobank, which manages the bank’s relationships with Non-Bank Financial Institutions, including government financial institutions, insurance companies, and asset managers. He is also the bank’s Financial Markets Strategist, focusing on fixed income and rates advisory for our high-net-worth-individual and institutional clients. He holds a Master’s in Business Administration from the University of Chicago Graduate School of Business. He is also an avid traveler and golfer.