A STRONG dollar and the preference for dollar-backed assets, like stocks, are the two main aspects of the fallout from higher interest rates in the US. That is why the Philippine stock market has been badly beaten and the peso is slowly creeping back to pre-financial crisis levels above P50 to a dollar in 2005.
It’s not entirely bad news, particularly for the families of 10 million or so overseas Filipinos who regularly send money to the Philippines, because the dependents of dollar earners would have more spending power in peso terms.
From the core perspective of US interest rates, it’s not that bad either. The Federal Reserve, the equivalent of the Bangko Sentral ng Pilipinas (BSP), raised the federal funds rate, or the interest rate that US financial institutions charge for lending to each other, by 25 basis points – that is 0.25 percentage point – to between 0.50 and 0.75 percent.
It marked the first time that the Fed has raised rates since December 2015 and only the second time in a decade. The Fed also indicated it expects to make more rate hikes in 2017. That’s according to Forbes USA, citing a story published on LearnVest.
The goal of the Fed at this point is to raise the benchmark interest rate to 1.25 percent. That is why it signaled more rate hikes in 2017. But even that is still low even as it started at nearly zero in 2015.
“Remember that even with a rate hike, interest rates are still historically very low. Case in point: Back in December 2006, before the height of the recession, the federal funds rate was above 5 percent. Back in the mid-to-late 1980s, it hovered closer to 10 percent and in the early 1980s, it was in the teens,” according to LearnVest.
The bigger picture here is that last week’s Fed decision, among other factors in the global arena, may impact on the credit standing of emerging markets that definitely include the Philippines, because of its timing. While the US economy is gaining enough traction on its way to recovery, other sovereign markets are not on the same boat and are in fact trying to keep afloat.
“The Fed’s tightening, while other major central banks such as the European Central Bank and Bank of Japan are easing, is likely to extend the current period of dollar strength. This could support growth in other advanced economies and counter deflationary pressures in the eurozone and Japan,” global debt watcher Fitch Ratings said in a note on Friday.
“But divergent monetary policies are one of a number of factors–including China’s gradual economic slowing and rebalancing, commodity price weakness, and geopolitical risks–that add to the potential for volatility in global bond markets, currencies, and capital flows. This may be accentuated by changes to regulations and market structure since the global financial crisis which appear to have reduced market liquidity and could hamper the rebalancing of investor portfolios in times of stress,” Fitch cautioned.
It is precisely those factors that would keep emerging markets like the Philippines on the edge and under pressure. In other words, along with structural growth challenges, emerging markets must be on guard even if vulnerabilities vary and no sovereign rating will be affected by an increase in the Fed funds rate alone.
“But the knock-on effects could be significant if international capital flows are redirected toward US assets, adding to possible pressure on sovereigns that rely on portfolio flows to finance current account deficits and raising the cost of refinancing external debt obligations, or prompting some emerging market central banks into their own, possibly pro-cyclical monetary tightening that further subdues growth,” Fitch further warned.
The Philippines is gunning for big stakes in trying to catch up with its more developed neighbors like Singapore, Malaysia and South Korea, while the BSP is busy trying to rein in the exchange rate through its open market operations by selling its dollar reserves to feed the ravenous market forces.
These are exciting times for financial markets and the economy, especially in 2017. It would be interesting to see how the administration’s economic managers will pull the strings to make the Philippines stand out among its peer markets and transform the country into a roaring tiger.
Let’s hope they deliver on their praise releases and don’t disappoint a nation of nearly 104 million.