Will the peso go to 60:$1?

The peso weakened again the past few weeks, going back above the 56 to $1 level. Understandably, many are concerned regarding the direction of the local currency. Is there something going on that will finally push the peso beyond the 60 to $1 level?

Personally, I think the likelihood of the peso weakening as sharply as it did last year is minimal. The main reason for the peso’s weakness this time around is the increasing probability that the Fed will raise rates by another 25 basis points in May.

Note that financial markets are now pricing in a 90-percent probability that the Fed will raise rates in its upcoming meeting. This as US inflation remains elevated, employment numbers remain strong and as actions taken by the Fed and other government agencies to control the risks resulting from the collapse of Silicon Valley Bank and Signature Bank in March are so far successful.

Another rate hike by the Fed will increase the interest rate differential between the peso and the dollar since the Bangko Sentral ng Pilipinas (BSP) said it might pause with its rate hikes if domestic inflation falls for a third month in a row in April.

Possible recession

However, I don’t think the Fed can continue raising rates after its May meeting since the probability of the United States entering a recession remains elevated. In fact, according to the minutes of the Fed’s March meeting, their own economists are expecting a mild recession later this year.

Although it’s true that US regulators were able to contain the panic that resulted from the collapse of the two banks earlier this year, banks are still expected to tighten their credit standards as they continue to suffer from huge mark-to-market losses on their long-term bond holdings, deposit flight and higher funding costs. Lack of credit will make it difficult for American consumers to make big-ticket purchases and for businesses to expand, negatively affecting economic growth.

If the United States enters a recession later this year, the Fed will be forced to cut rates. Moreover, potential rate cuts would most likely be aggressive as recessions lead to significant job losses, addressing the problem of inflation. Consequently, the Fed will be pushed to shift its focus from price stability to increasing employment. This in turn would require it to implement an accommodative monetary policy.

In contrast, the growth outlook of the Philippines is much better, as the economy is not expected to suffer from a recession this year. Because of this, the BSP is not expected to cut rates as aggressively as the Fed. This in turn will reduce the interest rate differential between the peso and the dollar, reducing the pressure for the peso to depreciate.

The main caveat to this view is the possibility that a recession in the U.S. would significantly increase volatility in global financial markets (like what happened during the 2007 Global Financial Crisis). If this materializes, there would be a flight to safety, leading to a stronger US dollar and a weaker peso.

However, there is also a possibility that global financial markets won’t suffer from heightened volatility. After all, this recession and market downturn will be the most anticipated in history, meaning that most fund managers are already preparing for it.