Long Philippine bonds likely out of favor on inflation fears

MOST SOUTHEAST ASIAN yield curves have flattened in recent months in tandem with a similar move in US Treasuries. The Philippines is an outlier.

The spread between five-year and 10-year peso bond yields is near the widest in over a year, with long-dated securities hit by fears about rising supply as the Philippines’ fiscal deficit widens. There’s little indication the gap will shrink as central bank policy anchors the short end of the curve while elevated inflation weighs on longer maturities.

The steeper curve could mean higher funding costs as the deficit widens to a record 9.3% of gross domestic product this year, although National Treasurer Rosalia V. de Leon expects the rise in yields to be temporary. Coming at a time when yield curves in Thailand and Malaysia are flattening, the steepening risks making longer-dated peso securities the region’s laggards.

“Relative to regional bonds, the outsized selloff in Philippine bonds is primarily due to a greater extent of widening in the inflation risk premium,” said Duncan Tan, a strategist at DBS Bank Ltd. in Singapore. “As long as energy prices stay supported, we expect Philippine bonds to underperform and the yield curve to steepen relative to regional curves.”

The spread between five-year and 10-year Philippine bonds stands at 117 basis points (bps). It reached 132 bps in late September, the widest in over a year.

In contrast, the Malaysian and Thai yield curves have narrowed by 21 bps and 17 bps, respectively, since early June as they mirrored a similar move in Treasuries.

This indicates the Philippine yield curve is unlikely to track a further flattening in its US counterpart, which may result in long-dated peso notes underperforming their regional peers. Swap traders expect the spread on 5- and 10-year Treasuries to narrow to 33 bps from 49 bps in a year’s time.

The Philippine curve may also steepen further as elevated price pressures drive up longer-dated yields while shorter maturities are anchored by the central bank’s pledge to hold off on interest rate hikes. Bangko Sentral ng Pilipinas has raised its 2021 average inflation target to 4.5% from 4.4%, above its target range of 2% to 4%, citing supply-side pressures.

Long-dated peso bonds will probably face further pressure from a heavy pipeline next year. While the budget deficit is expected to ease to 7.5% of GDP in 2022, the shortfall will still be wider than the pre-pandemic five-year average of 2.4%. With BSP signaling that it’ll continue to slow purchases of government debt for the rest of the year, there appears to be little respite in store. —

Bloomberg