The worst could be over soon
The worst seems far from over as inflation increased further to 6.1 percent in June, while the US Fed remains very hawkish as it plans to raise rates by another 50 to 75 basis points in its July meeting. Even our very own Bangko Sentral ng Pilipinas (BSP) Governor Felipe Medalla said that the local central bank may raise rates more aggressively this August in response to the sharp depreciation of the peso recently.
However, I believe that the worst may be over soon as far as inflation, interest rates and the peso are concerned, making it a good time to buy fixed income products and to start accumulating Philippine stocks.
The main reason why I think that the worst may be over soon is falling commodity prices. Note that prices of industrial metals are down sharply from their peak. In fact, copper is now trading below its end-2021 level despite being heavily used by the fast growing electronics vehicle industry.
Prices of soft commodities such as wheat are also down significantly from their peaks despite the ongoing war in Ukraine.
Commodity prices are falling as high prices and tight financial conditions resulting from higher interest rates are already resulting in demand destruction.
There are several indicators that demand for nonessential products is weakening.
For example, in the United States, retailers such as Walmart and Target are suffering from too much inventory. They attribute this to consumers shifting more of their spending on essentials, such as food, which have significantly increased in price. Chipmakers such as Micron and AMD also warned of weaker demand as sales of smartphones and computers are falling. They also attribute this to consumers spending more on essential products because of inflation.
If demand continues to weaken then commodity prices will sustain their downtrend. Inflation should consequently no longer be a problem. In fact, because of signs of weakening demand, more and more economists now believe that the United States could suffer from a recession soon. If this happens, then inflation would stay down, prompting the Fed to stop raising rates and potentially even cut rates.
Lower inflation coupled with a more dovish Fed should also help bring down interest rates locally. It would also help the peso stabilize. Note that one of the main reasons for the peso’s sharp depreciation recently is the strength of the US dollar.
While the Fed is expected to raise rates by a total of 325 basis points this year, the BSP is only expected to raise rates by a total of 100 basis points. The large yield differential makes the US dollar a more attractive currency to own compared to the Philippine peso, explaining the depreciation of the peso.
Fixed income products such as bonds and REITs will be the main beneficiaries of falling inflation and interest rates. This is because prices of bonds and REITs will immediately go up once interest rates drop as newly issued bonds and REITs will offer much lower yields.
However, stocks could stay depressed even with lower inflation and interest rates as the reason for the drop in inflation and interest rates is weaker demand, which will also hurt corporate profits.
Despite this, I believe that falling commodity prices and more accommodative central banks should help prevent prices of stocks from falling more sharply as businesses face less problems compared to earlier this year where they faced the risk of both weakening demand and rising costs because of high inflation.
Because of this and stocks’ very cheap valuations, I believe now is a good time to start accumulating stocks.
Moreover, as inflation and interest rates go down, demand should eventually recover as both consumers and businesses find it more lucrative to increase spending.
This, in turn, should help stocks rise and return to more normalized levels, benefiting investors who start accumulating stocks during these challenging times. INQ
