US Fed tapering, slowing China and ‘Abenomics’ in Japan watched

The first four months of the year was a good run for local financial markets.

Both the benchmark Philippine Stock Exchange Index (PSEi) and the peso were touted as among the best performers in the region. The Philippines, the former sick man of Asia, was suddenly the region’s “investment darling.”

But all this changed in May following signals that the US Federal Reserve may be ending its quantitative easing program amid signs of recovery in the world’s largest economy.

From being the world’s best-performing equity index in 2013, the PSEi fell into bear territory in a span of a few weeks. Also, the peso weakened to lows not seen in more than a year.

The events following the US Fed’s statements served as a reminder that any bull run can eventually hit a dead end.

Financial giant HSBC cites several developments that local investors should keep an eye on and the effects they may have on the economy and financial markets.

“Rates in the US are on their way up as prospects of tapering move closer,” the UK-based bank said in a quarterly report.

“In China, a spike in money market rates, even if temporary, signals the determination by officials to at least skim the froth off the top,” it said.

The Bangko Sentral ng Pilipinas (BSP) said the most obvious story worth following was the eventual tapering of the US Federal Reserve’s monthly $85-billion bond-buying program, which points to a hike in interest rates.

“The timing will be very important.  But we believe the Fed will approach this issue in an orderly fashion,” BSP Deputy Governor Diwa C. Guinigundo said.

Guinigundo said the Fed’s tapering was both a boon and a bane for the Philippine economy.

On one hand, the end to the bond buying program was a sign that the US economic recovery was gaining traction. This should translate to stronger demand for Philippine exports. The US, after all, is the Philippines’ biggest trading partner.

On the other hand, the more immediate effect of the Fed tapering would be a slowdown—if not a reversal—of the flood of foreign money that has benefited asset prices in emerging markets like the Philippines. A stronger US economy and higher interest rates will naturally attract foreign investors back to their home markets, which may mean they will pull out of countries like the Philippines.

BDO chief market strategist Jonathan Ravelas thinks most investors in the local market do not appreciate the implications of the Fed’s tapering.

“A lot of people still think that the peso will appreciate to 41-to-a-dollar,” Ravelas said. “They still haven’t priced in the tapering,” he said.

“It will be the world’s biggest economy that will be sucking the liquidity,” Ravelas said. “Everyone in the region will be affected. I agree it will be in varying degrees, but no one is safe,” he said.

Closer to home, BSP’s Guinigundo said China’s economic troubles, if these would persist, could send bigger shock waves throughout the region.

China, the region’s perennial growth driver and the world’s second largest economy, grew by 7.5 percent in the second quarter of 2013, slower than the 7.7 percent recorded in the previous quarter.

“China is still in a very challenging situation. There are liquidity issues, and whatever happens to China will have some spillover effects on us with respect to our position in the global supply chain,” Guinigundo said.

China may continue to struggle over its slowing economy, but Japan is seeing the reverse, Guinigundo said. He said Japan’s economic recovery would bode well for the Philippine economy. Japan is Asia’s second largest market and one of the Philippines’ major trading partners.

In its recent World Economic Outlook update, the International Monetary Fund (IMF) raised its growth forecast for Japan to reflect the expected impact of the recent easing of its monetary policies.

Both Japan and the Philippines are among the few countries whose growth forecasts were raised by the IMF. Japan is now expected to grow by 2 percent in 2013, faster than the 1.6 percent growth forecast of the IMF in April.

“Japan appears to have convinced the market that the ‘third arrow’ will start to work,” Guinigundo said, referring to Japanese Prime Minister Shinzo Abe’s recent reforms that were meant to make the economy more flexible.

Europe’s economic troubles also continue to give local policymakers headaches, Guinigundo said.

The Euro area’s economy is seen contracting in 2013 by 0.6 percent, the IMF’s latest forecast showed. The economies of France, Italy and Spain are seen shrinking this year before posting modest recovery in 2014.

Apart from being a major market for local exports, Europe also hosts a large concentration of overseas Filipino workers.

Despite the many threats to the real economy and local financial markets, policymakers and analysts remain in agreement that the Philippines has what it takes to weather the worst of the current financial storm.

On July 25, Moody’s Investor Service announced it was reviewing the ratings of long-term foreign and local currency bonds issued by the Philippine government for a possible upgrade.

Moody’s said it took note of the country’s recent track record of robust economic growth, stable and favorable government funding conditions, improving fiscal and debt dynamics, and political stability and a strengthened government policy mandate.

Ratings of government-issued IOUs serve as a proxy for the perceived health of a country’s economy. Moody’s remains the only credit rating company that considers Philippine government debt as “junk” investments. Its peers, Standard & Poor’s and Fitch Ratings, now consider the Philippines an “investment grade” investment.

For his part, BSP Governor Amando M. Tetangco Jr. said the Philippine economic fundamentals would be enough to counter the effects of any shock from abroad. Paolo G. Montecillo