PBoC steps up efforts to fight slowdown; Stay constructive on RPGBs
The People’s Bank of China injected RMB180bn into the market and trimmed the rates on 7D reverse repurchase agreements by 5bps to 2.5% on Monday. The moves came just two weeks after the authority cut the borrowing cost on its medium-term lending facility loans by the same margin. Both reductions were responses to October’s slowdown in domestic demand, in our view. In particular, the slump in loan data last month was beyond the typical seasonal pullback. And industrial profits have been under pressure from PPI deflation. The PBoC has pledged in its third quarter monetary policy report to step up “counter-cyclical adjustment” to ward off downward pressure on the economy while staying vigilant on widespread inflation. Even so, we believe disinflation is the primary concern given a tepid core inflation rate and falling producer prices. Monetary policy will hence remain accommodative. Monday’s repo rate cut bolstered the bond market, with the 10Y government bond yields falling to the lowest in a month. We continue to see 10Y CGB yields drifting towards 3% in the quarters ahead. Meanwhile, the loan prime rate will likely be lowered by 5-10bps on November 20 followed by more cuts in the coming months.
Rates: Stay constructive on RPGBs
Looking ahead into 2020, we remain constructive on Philippine Treasury Bonds (RPGB) even after this year's standout performance. While the year-to-date rally has been primarily driven by moderating inflation (compression of inflation risk premium), we think the drivers of outperformance ahead are likely to be more broad-based and like both short and long tenors.
Onshore factors could continue to anchor and hold yields low. Though inflation has likely bottomed and should rise ahead as high base effects fade, we expect it to be well-behaved within BSP’s 2-4% target range (DBS forecast for 2020: 3.1%). Compared to other regional central banks, BSP clearly has more room/scope to keep easing in 2020. With real rates presently quite high, BSP could further unwind 2018's policy rate hikes to support growth. Continuing to cut RRR in stages would also add more liquidity that could help to dampen any upward pressure on rates, e.g. from possible PHP weakness.
Considering the current macro backdrop, there is a lot to like about RPGBs vs other Asian bonds. Philippines’ economic outlook is considerably less challenging relative to other Asian economics and we are forecasting 2020 growth to be around 6.1% (ahead of China and India, just behind Vietnam). A stronger growth trajectory would be positive for credit metrics and could translate to lower borrowing costs. In terms of risks characteristics, we like that RPGBs have low sensitivities to the trajectory of US-China trade talks (hard to predict) and offer strong buffers against rising Core yields via steep curves and healthy rate differentials (vs US).
We are monitoring the risk that normalization of infrastructure spending (post mid-term elections and passing of 2019 budget) could pressure balance of payments (via increased capital imports) and significantly weaken the currency. For now though, we consider the risk to be low given partial offsets from stronger personal remittance and FDI inflows.
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