WHAT HAPPENED LAST WEEK

The peso government securities (GS) market saw strong buying interest across all tenors last week.

The 2.47x oversubscribed 6-year auction for the reissuance of Fixed Rate Treasury Note (FXTN) 10-64 prompted the rally early on as it was awarded at an average of 5.925%, or near the bottom band of market indications. The bond was taken down by 11.5 basis points (bps) to close the day following strong buying interest.

The move lower in US Treasury yields following the dovish hike by the US Federal Reserve further fueled risk-taking appetite in the local bond market, with players seen heavily positioning on long-tenored assets to maximize the sharp drop in yields and increase in bond prices.

The 20-year FXTN 20-25 was one of last week’s outperformers as it closed 23 bps lower for the week amid the lack of supply in this tenor bucket.

The lower-than-expected April inflation print of 6.6% vs the 7.0% estimate capped off a strong week for the peso GS market as players rode the momentum of the rally. Some, however, were already seen reducing positions or unloading to lock-in gains.

Short-term bonds saw some reprieve moving lower in yields, given the flatness of the peso yield curve, with 2-year FXTN 10-60 seeing decent buying interest to end the week.

Market Levels (week-on-week)

WHAT WE CAN EXPECT

At current levels, we recommend to remain nimble and take advantage of the move to lock-in gains in the peso GS space. We still think that it is prudent to load-up opportunistically in the upcoming auctions and patiently wait for any retracement higher in yields given the strength of the recent rally.

GERALDINE WAMBANGCO is a Financial Markets Analyst at the Institutional Investors Coverage Division, Financial Markets Sector, at Metrobank. She provides research and investment insights to high-net-worth clients. She is also a recent graduate of the bank’s Financial Markets Sector Training Program (FMSTP). She holds a Master’s in Industrial Economics (cum laude) from the University of Asia and the Pacific (UA&P). She takes a liking to history, astronomy, and Korean pop music.

WHAT HAPPENED LAST WEEK

Good demand was seen in medium to long-term peso government securities (GS), causing the local yield curve to significantly flatten, i.e., the recent fall in long-term peso yields and the rise in short-term yields.

The rally started after the Bureau of the Treasury (BTr) fully awarded the issuance of 7-year Fixed Rate Treasury Note (FXTN) 7-69 at a high of 6.06%, setting the coupon of the bond at 6.00%. Auction results showed strong participation as highlighted by the 2.47x bid-to-cover ratio.

Later in the week, the BTr announced its borrowing schedule for the month of May, saying that it would issue 6-, 7-, 9-, and 13-year tenor buckets for the month. The exclusion of a 20-year bond to be issued for the second straight month improved the appetite for longer tenors. FXTN 20-25 traded lower by 16.5 basis points (bps) for the week as it closed at a yield of 6.260%, whereas FXTN 25-7 ended the week at 6.165% or 7.5 bps lower.

To close the week, as dealers and end-user clients continued to load up on long-dated bonds, the yield curve further flattened due to the ample supply of short-term bonds being sold in the market. This caused the Retail Treasury Bond (RTB) 5-12 with a tenor of less than a year to trade at the 6.175%-level vs FXTN 20-25 at 6.260%.

Market Levels (week-on-week)

WHAT WE CAN EXPECT

We expect good demand on the 6-year FXTN 10-64 auction, especially on the higher-end of market indications as we continue to see healthy buying demand to come out this week, just after the success of the FXTN 7-69 auction last week.

Given the significant flattening of the yield curve, we see decent value in holding short-term Treasury bills (T-bills) combined with bonds with tenors of less than one year due to their relative value as compared to long-term peso GS. RTB 5-12 is now yielding higher at 6.175% than FXTN 20-25 trading at 6.260%.

Other than the auction, investors and dealers will look at this Friday’s local inflation print for a longer-term view, where the Bangko Sentral ng Pilipinas’ (BSP) latest estimate stands at 6.3-7.1%. The Bloomberg consensus, on the other hand, is expecting inflation to be at the higher end of that range with a consensus of 7.0%.

GERALDINE WAMBANGCO is a Financial Markets Analyst at the Institutional Investors Coverage Division, Financial Markets Sector, at Metrobank. She provides research and investment insights to high-net-worth clients. She is also a recent graduate of the bank’s Financial Markets Sector Training Program (FMSTP). She holds a Master’s in Industrial Economics (cum laude) from the University of Asia and the Pacific (UA&P). She takes a liking to history, astronomy, and Korean pop music.

Investors of peso government securities (GS) may be pleased to see that the prices of their long-term bonds in the 12- to 20-year tenor buckets have richened over the past few weeks.

The appetite for peso GS significantly picked up, thanks to slower inflation, an influx of liquidity from bond maturities, and the Bureau of the Treasury’s resolve to cap awards in recent auctions.

WHAT HAPPENED LAST WEEK

It was relatively quiet for the peso government securities (GS) market last week due to the lack of significant news to move the market. As such, dealers were mostly seen managing client flows for the better part of the week.

Heading into the Fixed Rate Treasury Note (FXTN) 13-1 auction last week, selling interest was still seen in short-dated bonds, possibly on the back of high dollar-peso exchange rate and clients just freeing up liquidity.

The Bureau of the Treasury (BTr) partially awarded the first 13-year auction at a high of 6.35%, setting the coupon rate of FXTN 13-1 at 6.25% or at the lower end of market indications. With the BTr capping the awards of the auction as they are still ahead of their borrowing program, decent buying interest both from dealers and clients occured in the afternoon session, pushing prices up to cut early losses seen in the day.

Overall, yields of short-dated peso GS pushed higher on a week-on-week (WoW) perspective. Retail Treasury Bond (RTB) 3-11 rose by around 5 basis points (bps), whereas RTB 5-12 rose by 15 bps for the week. Treasury Bills (T-bills) were also generally higher by around 5-

WHAT HAPPENED LAST WEEK

Ahead of the scheduled 10-year auction last week, selling interest was initially seen on the 10- to 20-year tenors, which led yields 2 to 7 basis points (bps) higher. The Bureau of the Treasury (BTr) then fully awarded the re-issuance of FXTN 10-69 at an average rate of 6.142% and a high of 6.18%, or near the higher end of the market’s expected range.

Last Wednesday, despite lower US Treasury yields following the US inflation data, slight profit-taking and de-risking were seen in the GS space as yields proceeded to trade higher by 2 to 2.5 bps.

Decent demand for medium- to long-term GS continued to support yields in these tenors for the remainder of the week. However, investors continued to sell short-dated T-bills and bonds in anticipation of higher short-term yields. Overall, short-term GS rose 10 to 12 bps while medium and long-term bonds rose 3 to 7 bps.

Market Levels (week-on-week)

Swiss regulators recently wiped out USD 17 billion of Credit Suisse’s Additional Tier 1 bonds as part of an agreement for UBS to rescue its struggling rival. The news about these two big Swiss banks sent shockwaves through the financial markets, with investors now wondering just what makes these bank-issued bonds so different from the rest.

1. The most junior form of liability… or is it equity?

True to its name, Additional Tier 1 (AT1) bonds add to a bank’s Common Equity Tier 1 (CET1), which measures a bank’s financial strength and includes its common shares of stock and retained earnings.

This makes AT1 bonds the most junior form of debt, and, in times of crisis, they are the first to incur losses after a bank’s shareholders.

 Source: CreditSights

AT1 bonds also fall under a broader term called Contingent Convertibles or CoCos – hybrid securities with features common to both bonds and stocks. In the case of AT1 bonds, a bank with severely low capital ratios may trigger a conversion of the bonds into equity shares of stock.

2. Regulators can enforce a complete write-off.

Worse yet, if a bank is no longer able to operate due to insufficient liquidity or capital or both, then the handling regulatory body can choose to completely write-off the bank’s outstanding AT1 bond issuances.

In the case of Credit Suisse, its AT1 bondholders were furious that a write-off was triggered, considering that the bank was still operational, and its shareholders would continue to benefit from the UBS takeover.

However, the bond prospectus contained language that allowed for the bonds to be written off if “extraordinary government support is granted.” The European Central Bank and Bank of England were quick to announce that bondholders of banks under their jurisdiction will continue to enjoy seniority over shareholders. Nevertheless, it does not change the fact that all AT1 bonds can be reduced to nothing if the situation calls for it.

3. Higher yielding… if the bank pays.

Given their low seniority in the capital structure and the possibility of conversion into equity or write-off, AT1 bonds tend to be issued at higher coupon rates to compensate investors for the added risks. However, a bank may choose not to pay coupons on these bonds if it is unable to do so.

AT1 bonds are also perpetual bonds, which means that they do not have a specific maturity date. Instead, they have call dates when a bank may choose to buy back the bonds from investors. Normally, this is done in a low-interest environment so that a bank can refinance its debt at a cheaper rate.

When traded on the secondary market, AT1 bonds sometimes offer above-average yields, since prices can be so volatile. This yield is also known as the yield-to-call (YTC). While the returns may look attractive relative to other more senior bonds, the YTC is realized only if a bank is able to pay its coupons and buy the AT1 bond back from the investor on the next call date.

In summary, Additional Tier 1 bonds are hybrid securities issued by banks to raise additional capital. During periods of financial distress, AT1 bonds may be converted into equity shares of stock or completely written off by regulators.

Because of these added risks, investors are compensated with relatively higher coupon rates. However, banks may choose not to pay coupons or the principal amounts as they are due.

Given all these conditions, are AT1 bonds for you? It will depend greatly on your own financial sophistication and risk appetite. A well-performing bank and the right economic conditions can help turn AT1 bonds into great investment opportunities.

But with global interest rates approaching their peak, we see just as much value in other safer investments issued by governments, such as sovereign bonds and peso government securities, which promise punctual coupon and principal payments.

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.

WHAT HAPPENED LAST WEEK

In last week’s session, follow-through buying was seen in the peso government securities (GS) market with the yield curve continuing to flatten.

Prior to any local economic data release, US Treasury yields were seen trending lower, providing additional support for peso GS. Buying interest was consistently seen in the 19.6-year Fixed Rate Treasury Note (FXTN) 20-25 amid the absence of bond supply in this month’s borrowing program.

Before the week ended for the local holidays, the market welcomed the March inflation print, which decelerated to 7.6%, lower than the market consensus rate of 8%. After hitting a 14-year high in January, prices of goods and services have cooled to a six-month low.

This news led to another round of buying from both dealers and clients. Department of Finance Secretary (DOF) Secretary Benjamin Diokno also said that the softer-than-expected inflation print supports the view that the Bangko Sentral ng Pilipinas (BSP) has done enough to tame inflation.

On a week-on-week basis, local yields fell by 5-14 basis points (bps) with long-term yields decreasing faster than those of short-term yields as

Last March 23, 2023, the Bangko Sentral ng Pilipinas (BSP) raised rates by only 25 basis points (bps) from 6.00% to 6.25%. While it is smaller relative to recent hikes, the move still brought the policy rate to its highest level in the last 16 years.

Naturally, one would assume that higher prevailing interest rates would result in higher interest-bearing investments. But that is not always the case.

Inflation expectations matter

March 2023 inflation has come out much softer than expected at 7.6% year-on-year versus 8% forecast and 8.6% the previous month.

Now investors are starting to think that inflation is on a sustained downtrend and the BSP may not need to hike interest rates any further. We expect the full year Consumer Price Index (CPI) to average between 6% to 7%, driven by lower fuel prices, base effects from already elevated 2022 prices, and a potential global economic slowdown.

The BSP could hold its policy rate at 6.25% or hike to 6.50% in May. But as the CPI continues to decelerate, our research team forecasts that the BSP will cut rates back down to 6.00% in December, in order to signal the beginning of a new easing cycle in 2024.

Chasing after peak interest rates

For this reason, investors are abandoning short-term treasury bills (3 months to 1 year) and instead buying long-term treasury bonds (greater than 1 year) in order to lock-in yields before an imminent drop in inflation and hence, interest rates.

With the Bureau of Treasury (BTr) also about 40% done with its domestic borrowing plan, it is unclear just how many new long-term bonds will continue to be issued at the current rates. This uncertainty regarding bond supply pushes investors to chase after the peak and the surging demand inadvertently causes bond yields to fall.

The chart below shows the movement in the peso government securities yield curve from the ends of 4Q 2022 to 1Q 2023. The sell-off in short-term treasury bills caused yields to rise by 75-80 bps. Conversely, greater demand for long-term treasury bonds caused yields to fall by as little as 35 bps on 3-year bonds to as large as 77 bps on 10-year bonds.

The chart also shows where our government securities traders forecast yields to fall by the end of the year. They expect the short-term yields to return lower by 75-85 bps and for the long-term yields to fall by another 20-40 bps.

Add duration and lock in bond yields for longer

Even though yields have fallen from their 2022 highs, this is still a once-in-a-lifetime opportunity to invest in bonds at the peak of a high interest rate environment.

We encourage clients to invest in 10- to 20-year bonds now. Higher-duration or longer-tenor bonds are also more sensitive to changes in interest rates. If the BSP starts cutting interest rates, new bonds will get issued at lower coupon rates and investors may see their long-term bonds appreciate.

While we encourage investors to hold onto their bonds until maturity date, wealth can also be created when selling higher yielding bonds in a low interest rate environment.

For more information on how you can invest in or trade government securities with Metrobank, please reach out to your relationship manager or investment specialist, or visit the nearest branch.

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.