Currencies 5 MIN READ

The US dollar isn’t out just yet

There’s still greater demand for US dollars and USD-denominated assets but could the recent US banking issues hold bank the greenback’s strength?

March 22, 2023By EA Aguirre

Markets underestimated Fed hawkishness as the risk rally that started in January saw a complete reversal in February.

It started when US non-farm payrolls for January exceeded expectations, adding 517,000 new jobs versus 189,000 forecast. The unemployment rate also fell to a 53-year low of 3.4% with two job openings for every unemployed individual, further highlighting the strong labor market.

US inflation indices also surprised everyone by coming out higher than expected. The consumer price index (CPI) grew by 6.4% year-on-year versus 6.2% forecast while the Fed’s preferred inflation gauge, the core personal consumption expenditure (PCE) increased 4.7% year-on-year versus 3.9% forecast. Other economic data releases in retail sales and purchasing managers index (PMI) showed robust business activity, despite elevated interest rates.

However, US dollar may see another challenge to its strength as the bank runs on Silicon Valley Bank (SVB) and other smaller financial institutions in March have investors thinking that the Fed may have tightened too much. European currencies such as the euro and pound sterling are also adversely affected by struggling Credit Suisse.

Month-on-month change of major currency pairs – Feb 2023

It did not help that Japan’s 4Q 2022 gross domestic product (GDP) grew at a much weaker 0.6% versus 2% forecast, as the return of tourists was not able to offset a slowdown in capital expenditure and exports. The Bank of Japan (BOJ) also maintained the status quo of loose monetary policy and incoming BOJ Governor Kazuo Ueda has not made any opposing comments, despite initial hawkish impressions. USD/JPY went from a low of 128.68 in the first couple of days to trending upward all the way back above the 136.17 by February 24.

But with the Japanese yen, traditionally a safe haven currency, Japan could still see flows coming in from troubled banks in the US and Europe.

European Central Bank (ECB) President Christine Lagarde reiterated that the central bank will likely hike by 50 basis points (bps) in March to a 3% deposit rate, even as Euro zone inflation slowed from 9.2% in December to 8.6% in January. However, the EUR/USD still fell from a high of 1.0990 on the first day of the month all the way down to 1.0548 as US dollar strength dominated. The euro’s only reprieve is that the European Union (EU) has been able to completely replace Russian oil imports with supply from US, Norway and Qatar, tempering domestic demand for US dollars.

The pound sterling was still able to put up a fight as United Kingdom (UK) 4Q 2022 GDP grew by 0.4% amidst recession fears. GBP/USD traded from a high of 1.2376 down to a low of 1.1944 on February 24, but bounced back to 1.2022 by the end of the month. January UK inflation also remained elevated at 10.1% which could necessitate further rate hikes by the Bank of England (BOE).

However, both currencies are at risk should issues surrounding Credit Suisse’s stability negatively affect confidence in the European banking system. Immediately after SVB’s closure, Credit Suisse and the Swiss National Bank quickly initiated talks to reassure the public that the bank will not fail.

Optimism on China’s reopening waned as the giant did not have its explosive start and impact on commodity markets as anticipated. West Texas Intermediate (WTI) Crude Oil decreased slightly, from an average price of USD 78.16/barrel in January to USD 76.86/barrel in February. Gold and copper prices also decreased by coming from a sustained rally in January.

Canada CPI continued its descent with the January figure slowing to 5.9% year-on-year, reaffirming the Bank of Canada’s (BOC) decision to pause its hiking cycle at 4.5%. USD/CAD started the month at 1.3291 and has climbed to 1.3647 by the end, driven by a hawkish Fed in contrast with a dovish BOC.

With 4Q 2022 inflation for both Australia and New Zealand well above 7%, the Reserve Bank of Australia (RBA) hiked 25 bps to 3.35% while the Reserve Bank of New Zealand (RBNZ) hiked an even greater 50 bps to 4.75%. AUD/USD fell from 0.7137 down to 0.6726 and NZD/USD fell from 0.6506 down to 0.6185. AUD underperformed the most also because of weakness in the Australian job market.

China was still in a slow start, especially since the nation was coming from its Lunar New Year holidays.

Relations between the US and China soured after a Chinese-operated balloon off the southeastern US coast was shot down after being suspected over spying on US military sites. China claimed the balloon was just a weather-monitoring device that accidentally drifted into US airspace.

The offshore yuan started the month at 6.7195 and ended it at 6.9810. With record low 4Q 2022 GDP growth of 2.9% and January inflation at 2.1%, the People’s Bank of China (PBOC) is in no hurry to be hawkish and might instead consider more growth-centered policy.

The above forecasts are the foreign exchange traders’ personal opinions and may not reflect the official views of the bank.

Our FX traders’ personal views have altered slightly to account for greater US dollar strength than originally anticipated. A strong labor market and sticky inflation will have markets continuously on the lookout for the Fed’s terminal rate. The higher and longer US rates are projected to be, the greater the demand for US dollars and USD-denominated assets. But with the issues surrounding SVB and US regional banks, it remains to be seen whether the USD can hold onto its strength or whether the Fed can remain hawkish for longer.

Earl Andrew “EA” Aguirre is a Market Strategist at Metrobank’s Financial Markets Sector and has 10 years of experience in foreign exchange, fixed income securities, and derivatives sales. He has a Master’s in Business Administration from the Ateneo Graduate School of Business. His interests include regularly traveling to Japan and learning its language and culture.

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Currencies 4 MIN READ

EUR/USD trade opportunities still abundant despite inflation

Despite ongoing issues with banks such as SVB in the US, the market’s attention will still look at the Fed’s hawkish rhetoric as a reaction to a hot labor market and elevated inflation. But our FX traders still expect the euro to return to its previous bullish trend in the medium term.

March 15, 2023By EA Aguirre

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The first few days of March 2023 saw surprises in Eurozone inflation figures. Both France and Spain saw unexpected increases in their February consumer price indices (CPI), printing at 7.2% and 6.1% year-on-year respectively.

This marks the third consecutive month of rising inflation for both nations as they continue to contend with higher food and services costs. German CPI also stayed sticky at 8.7% year-on-year vs. the same figure in January, despite cooling energy prices due to a warmer winter.

The consolidated inflation figure for the 20-nation bloc Eurozone remained elevated, printing at 8.5% year-on-year vs. 8.6% in January and beating 8.2% consensus forecast. Core CPI, which excludes volatile food and energy prices, even hit a new high of 5.6% vs. 5.3% the previous month, signaling that services inflation in the Eurozone has not yet peaked.

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Currencies 5 MIN READ

Global Currencies: Strong USD to remain in Q1 2023

The resilient US labor market and inflation will keep the US dollar strong against global peers. Challenges, however, abound for the rest of the year.

February 21, 2023By EA Aguirre

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The US dollar is expected to remain steady against other global currency peers, which can lead to more purchases of the US dollar for the first quarter of 2023.

But the overall direction for the year is for the US dollar to depreciate as global central banks continue to pursue their own paths to monetary policy normalization and as the US runs the risk of a possible recession.

Six consecutive months of declining US inflation and inconsistent statements from the Federal Reserve Chair Jerome Powell were enough to bring about a bearish US dollar story in January.

The Dollar Currency Index (DXY), which measures the strength of the dollar against a basket of major currency peers, fell by 1.36%, as markets started to price in an end to monetary policy tightening and possible interest rate cut by the 2nd half of 2023.

However, with a resilient US labor market and inflation just meeting expectations, our foreign exchange traders still expect high US rates and bouts of US dollar strength to persist.

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Currencies 2 MIN READ

Forecast updates: Dollar-peso exchange rate likely to be lower

The US Fed hiked rates by 25 basis points, inflation is on a downward trajectory, the markets have priced in less aggressive moves by the Fed. Where will we see the peso going now?

February 2, 2023By Metrobank Research

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With the latest developments in the markets and the direction of monetary policy in the US, we believe that the peso will appreciate this year and a bit more in the next.

We have revised our forecast downward to PHP 55.1 to the dollar for 2023, and PHP 54.4 for 2024.

US Fed action

The US Federal Reserve, in its latest Federal Open Market Committee (FOMC) meeting, has again hiked its benchmark interest rates, albeit by a smaller increment of 25 basis points (bps), raising the target range for the federal funds rate from 4.25%-4.5% to 4.5% – 4.75%.

US inflation has been on a downward trajectory since July 2022, but the FOMC reiterated in its statement that despite signs of easing, inflation remains elevated and that it will take the appropriate policy measures to achieve its 2% inflation target.

US Fed Chair Jerome Powell added that while long-term inflation expectations appear optimistic, they do not offer room for complacency, and thus signaled that a restrictive policy will remain for some time.

Market response

Even prior to the FOMC meeting, the markets ha

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Currencies 3 MIN READ

USD/PHP 2023 outlook: Don’t bet on a sustainably stronger peso

For those watching the movement of the dollar-peso exchange rate, the recent strengthening of the peso, while desirable for some, may be fleeting.

December 8, 2022By Patty Membrebe
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In the past week, the peso strengthened 1.12% versus the US dollar. Year-to-date, however, the local currency has weakened by as much as 13.6%.

The current dip in the dollar-peso exchange rate comes on the heels of a downward momentum in the broad US dollar index, as markets become more optimistic about the US Fed slowing the pace of rate hikes and a possible China reopening next year.

After trading at 20-year highs this year, the US dollar has come off its peak. Now, the question is: Will the US dollar continue to weaken in the coming months?

We cite three main reasons why we think the answer is no.

 1. Negative real rates and a still narrow interest rate differential (IRD).

Our base case for the US economy in 2023 is a “bumpy” soft landing, characterized by modestly positive GDP growth (0% to 1%, in line with 2022 levels) and moderating inflation. We estimate 2023 full-year US average headline inflation to slow to 4.3%, from an estimated average of 8.1% in 2022.

After four consecutive 75-bp hikes since June, we expect the US Fed to slow their tightening by 50 basis points (bps) to 4.5% (from 4% currently) in the n

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Currencies 3 MIN READ

Metrobank’s view: ‘Hold on to your dollars’

Will the peso depreciate even more before the year is out? Metrobank’s foreign exchange division head gives us some clarity.

September 12, 2022By Anthony O. Alcantara

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The peso’s recent slide is not a cause for alarm, at least for now, Armand Barlis, Head of Metrobank’s Foreign Exchange Division, said.

“Since the start of the year, the expectation has really been for a weaker peso,” he said.

“There are a lot of factors, such as the country’s growing fiscal and trade deficits, but the most important factor is the prospect of faster rate hikes in the US, which has led the US dollar to soar globally,” he added.

The peso, which has fallen by 12 percent since December 2021, is not alone in its plight.

The Japanese yen has lost around 20 percent in value against the US dollar, while the Korean won has slid around 17 percent in the same period. Other Asian currencies depreciated by around 8 percent on the average.

“So, it is really not so bad in terms of competitiveness, if we consider that all the other currencies have depreciated too,” said Barlis.

While he thinks the peso can depreciate a bit more above 57.00 in the near term, there are signs of stalling and should settle at around PHP 56.45 to PHP 56.50 to the dollar by the end of the year.

‘Imported inflation’

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Currencies 3 MIN READ

Exchange rates: A game of tradeoffs

Who wins and who loses when the peso appreciates or depreciates? Who determines the price of the peso in a floating exchange rate regime? Contrary to what most may think, it is neither the BSP nor the government that sets the price.

July 19, 2022By Anna Isabelle Lejano

With the peso breaching PHP 56 to a dollar, concerns over a weakening economy have been raised. This depreciation was caused by surging global prices due to energy supply chain disruptions from the Russian-Ukraine conflict and the subsequent US Federal Reserve (Fed) rate hikes to tame inflation, strengthening the US dollar. Now, what are the implications of this depreciation? And what are the tradeoffs?

A peso depreciation can make imports more expensive since it costs more in Philippine pesos to buy foreign goods. Basic commodities also become more costly with rising inflation, and debt that is denominated in foreign currency gets bloated.

On the other hand, a depreciated peso also has its benefits as it can help increase dollar inflows. It can boost exports since trade partners can buy more goods and services from the Philippines using the same amount of US dollars, which results in the competitiveness of the country’s products.

It can also make tourism, particularly accommodation and other travel-related amenities, more affordable for international tourists. Additionally, families receiving remittances from overseas Filipino workers (OFWs) will see more pesos for every dollar sent home. There would also be an increase in the value of the dollar earnings of the Business Process Outsourcing (BPO) sector. Also, a depreciated peso can serve as a deterrent to buying non-essential imports, which can help conserve dollars.

The reverse process goes for peso appreciation. An appreciated peso would make exports more costly and would result in a less competitive BPO and tourism sector. It would also lower the peso value of OFW remittances. On the upside, it could make imports cheaper, reduce consumer prices or temper inflation, and shrink the value of foreign currency-denominated debt. On the other hand, it can induce the buying of non-essential imports, which can deplete dollar reserves.

All about tradeoffs

So, is there a real answer as to which is better? Is it currency appreciation or depreciation? An exporter would want a depreciated currency, but an importer would want otherwise. Would you side with the exporter or the importer? An OFW would want a depreciated peso, but this might elevate prices back at home. Would you side with the OFW?

This goes to show that there are no real solutions or answers. There are only tradeoffs. With this, the tension between these tradeoffs pushes the market towards one way or another, towards appreciation or depreciation. That is, it is the market that gets to decide where the exchange rate would be.

Since there are only trade-offs, what is clear is that a too fast appreciation or depreciation can destabilize markets. Ideally markets best operate in a smooth and regular way, able to sort things out in an orderly fashion. The chaos and confusion caused by very fast currency movements can result in market panics that only make things worse as players exaggerate market swings and make adverse self-fulfilling prophecies.

This is where the BSP comes in. It manages volatility because it does not want too fast movements in the exchange rate. It does not set the exchange rate itself, but it can buy or sell dollars in the markets to manage volatility or tweak policy rates to contain inflationary pressure from a fast-depreciating peso. However, neither the BSP nor the government actually decides who wins or who loses. In the end, it is the market that decides in this ever-moving game of trade-offs.

ANNA ISABELLE “BEA” LEJANO is a Research & Business Analytics Officer at Metrobank, in charge of the bank’s research on the macroeconomy and the banking industry. She obtained her Bachelor’s degree in Business Economics from the University of the Philippines School of Economics and is currently taking up her Master’s in Economics degree at the Ateneo de Manila University. She cannot function without coffee.

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Currencies 4 MIN READ

A perfect storm for the Philippine peso

Many factors are contributing to the peso’s woes. Inflation in the US is a major one. High inflation, however, may be over in a few months, if history is any guide.

July 18, 2022By Ruben Zamora

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.

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Currencies 4 MIN READ

A strong dollar story: Peso plays “depreciation catch-up”

Did the peso depreciate much more than other ASEAN currencies against the US dollar? It seems the peso is just playing “depreciation catch-up” against the backdrop of a strong dollar.

July 1, 2022By Marc Bautista, CFA

The US Federal Reserve has been hiking its Fed Funds rate aggressively in the past few meetings, with the latest at 75 basis points (bps) and with further signals of another 50- to 75-bp hike this July, and more to come afterwards. The result is a renewed interest in US financial assets, which also generally translates to a strong dollar as investors buy dollars and sell whatever currencies they may have.

For the Philippines, this means a depreciating peso. As the chart below shows, the peso generally depreciates when the Fed Funds rate go up, and it appreciates when the Fed Funds rate comes down, at least trend-wise.

For example, in the period following the Great Recession of 2008, the effective Fed Funds rate came all the way down to near zero and, as a result, the peso generally appreciated all the way to 2013. On the other hand, between 2015 and 2019, the peso depreciated as the Fed Funds rate went up.

Market expectations drive the movement of the peso exchange rate.

However, there was a curious situation highlighted in the chart in 2013. It shows the peso actually depreciating way before the Fed actually started hiking rates in 2015. So, what gives? It turns out that the Fed started talking about tightening monetary policy in 2013 and, as a result, the peso depreciated.

So, it’s not just actual rate cuts or hikes that move the peso, but also market expectations of rate cuts or hikes. Therefore, market expectations of what the Fed will do is as important as what the Fed actually does, and these expectations actually move the exchange rate directly. The same was true in 2021, as market expectations of Fed hikes started to push up the peso and make it depreciate, even though the Fed actually started raising rates only this 2022.

It also appears that with the expected aggressive rate hikes, the markets are pricing in an even weaker peso, with the peso hitting the 55 level already, up from 51 at the start of 2022. However, currently, there is a bit of market noise on just how far up the peso is expected to weaken. In light of recent movements in other currencies, it might appear that the peso is weakening too much when looking at the recent past. However, when taking a look at a longer window, it can also appear that the peso in fact is just playing catch-up with the rest of the pack.

In this chart below, movements of the ASEAN currencies plus the yen are converted to an index based on January 2018. The overall changes relative to the base are then tracked for comparison. The 2018 base was chosen given that then, as now, there was high inflation for the Philippines.

It turns out that when tracked this way, the peso is not the currency that depreciated the most. Our ASEAN peers plus Japan have currencies that depreciated even more than the peso relative to 2018 prices.

The peso did not perform as badly as other ASEAN currencies as many may think. With high economic growth and strong imports, the peso is now playing “depreciation catch-up”.

It is perhaps not that relevant to ask whether the peso is leading the pack or is behind the pack in terms of depreciation given the different ways the observation window can be framed. Perhaps the real question should be, why did the peso appreciate too much in 2020 to 2021 relative to the pack?

That answer is simple; it’s because the country did not import that much during that period due to demand destruction and the lockdowns. However, OFW remittances and BPO revenues continued to come in and dominate the balance of payments, leading to peso strength. Our peers, on the other hand, are export- oriented, heavily dependent on the trade of goods (or tourism, in the case of Thailand) which, of course, collapsed due to the pandemic lockdowns. As a result, their currencies didn’t appreciate as much as the peso.

And because of that, the “base effect” is much more significant for the Philippines as the Fed started signaling rate hikes in 2021, completely reversing the trend. The peso is playing “depreciation catch-up” (with heightened base effects) with its peers as high economic growth, and thus, strong imports, are back in play.

Ah, yes, economic growth! With continuing growth, there will be more imports at higher inflated global prices, and the 3rd quarter is traditionally when imports are strongest. It should be expected that the peso will continue to weaken at this point.

When imports ebb by the 4th quarter and OFW remittances start to dominate once again going into the Christmas season, and with BPOs continuing to become even more competitive given the weaker peso, the peso should start getting appreciation pressure towards yearend. All the while, the Fed rate hikes will continue way into 2023. In the end, the call is still a weaker peso. After all, it’s still a strong dollar story.

MARC BAUTISTA, CFA, is Vice-President and Head of Research & Business Analytics at Metrobank, in charge of the Bank’s macroeconomic, industry, and financial market analysis and research. He loves teaching finance and investments, portfolio management, statistics, financial derivatives, economics, etc. in a university setting. He plays guitar in a rock band and loves learning other languages, especially Spanish, promoting its recovery as a heritage language in the Philippines.

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Currencies 4 MIN READ

What to do when the peso plunges to a 17-year low

There are forces pushing the value of the dollar up. Increasing policy rates in the US are mostly to blame. For now, we continue to advocate buying on dips.

June 28, 2022By Ruben Zamora

The Philippine peso has weakened sharply against the US dollar, trading close to PHP 55 to a dollar, a level not seen since November 2005. So far this year, the peso is down over 7% vs the greenback, making it the worst-performing ASEAN currency.

As all Asian currencies weakened against the US dollar in 2022, central banks in Asia are tapping into their stockpiles to bolster their weakening currencies.

What happened?

Inflation happened. More specifically, it is the four-decade high inflation in the US, which has forced the US Federal Reserve to raise rates very quickly and by a lot more than initially expected.

On June 15, the Fed hiked its benchmark interest rate by 75 basis points (0.75 percentage points) to 1.5%-1.75%, the third consecutive rate increase in as many meetings, and the largest single rate hike since 1994. Leading up to the rate policy-setting meeting, Fed Chairman Jerome Powell signaled an increase closer to 50 bps, but after higher-than-expected inflation of 8.6% for May, the Fed decided time wasn’t on their side to cool inflation down. Just as critical, the Fed said that it will continue doing what’s needed until there’s evidence that inflation is slowing. From inflation shock, we’re now in a rate shock.

Global markets, including foreign exchange markets, immediately reset expectations on US rates to between 3.5%-4% by year-end 2022, up from 2.75% just a month ago.

The higher the interest rate of a currency, the more valuable that currency becomes, and with US interest rates rising faster than those of other countries, including the Philippines, the US dollar very quickly jumped higher against the peso.

Why won’t we keep pace with the Fed to defend the peso?

Because economic recovery comes first, at least for now.

The Philippine economic recovery remains precarious compared to the US and other advanced economies that came out of the pandemic much earlier. The Bangko Sentral ng Pilipinas (BSP) is therefore wary about hitting the brakes on growth by raising rates too early. A more gradual approach was deemed necessary.

The BSP started “normalizing” its benchmark policy rates from the historic-low 2% level, which was needed to support the economy during the pandemic, with a nice-and-easy 25-bp rate hike on May 19, two months after the Fed’s rate lift-off.

The BSP responded with another 25-bp hike in the following policy rate-setting meeting on June 23, after inflation registered a 5.40% year-on-year jump in May and on expectations of accelerating inflation.

Due to higher global oil and non-oil prices, combined with the continuing shortage in domestic food supply, particularly fish, the BSP raised its average inflation forecasts to 5% in 2022, from 4.6% previously, thereby implying average inflation of 5.6% in the 2nd half of 2022; and to 4.2% in 2023, from 3.9% previously, before tapering back to a 3.3% average in 2024.

The BSP’s two consecutive rate hikes have brought the policy rate to 2.5%, compared to the Fed Fund Rate’s current level of 1.75%, or a 75-bp interest rate differential compared to the historical average of 250 bps.

The interest rate differential of the BSP’s Overnight Rate and the Fed Funds Rate now stands at 75 basis points (bps) compared to the historical average of 250 bps.

Similar to the Fed, the BSP said it is prepared to take the necessary policy actions to bring inflation back to within the 2%-4% range target over the medium term, which includes further rate hikes through the second half of 2022.

However, given the divergent policy rate path between the Fed (aggressively “hawkish”) and the BSP (persistently “dovish”), this interest rate differential will narrow quickly, and might even turn negative (where the US interest rate is higher than the Philippine interest rate).

Metrobank Research Head Marc Bautista forecasts the BSP policy rate at 3% – 5% by year-end 2022, or another minimum 50-bp hike from here, significantly slower than the 175-bp to 225-bp expected cumulative rate hikes of the Fed.

We believe this is why the peso has weakened considerably against the US dollar and is at risk of weakening further, especially after incoming BSP Governor Felipe Medalla said that the BSP’s focus will be inflation, more than the exchange rate. This may be exacerbated as demand for the US dollar picks up ahead of peak import season in the third quarter.

Metrobank Research recently revised their exchange rate forecast to PHP 55.10 by year-end 2022 (up from PHP 53.40 previously) and PHP 56.50 by year-end 2023 (from PHP 54.70 previously), near the all-time high of PHP 56.45/USD 1 on March 31, 2004.

So what do we do now?

We’ve consistently been advocating buying the US dollar vs the peso on dips since last year. Our Financial Markets Analyst Patty Membrebe reiterated this view in her recent article, “Why buy the dollar on dips” published last May 30. Given our revised forecasts, we are keeping this strategy intact.

In the near-term, the peso appears technically oversold against the US dollar, which suggests room for a pull-back towards the 54.65-level, which could offer a window to accumulate dollars. Should the exchange rate break below this level, we see the next support at 54.50. For those who can afford to wait, the peso tends to get stronger against the dollar in the fourth quarter, when strong demand for imports goes down and seasonal OFW remittances go up.

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.

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