Sell-off in Philippine bills subsides, outlook wary

By Saikat Chatterjee , Reuters

Posted at Jan 27 2011 04:27 PM | Updated as of Jan 28 2011 12:27 AM

HONG KONG - A sell-off in Philippine bills tapered off before a slew of data next week but sentiment remained wary as yields traded below policy rates.

Both rates and the currency have been hit by the double whammy of the fading effect of a dollar squeeze orchestrated by the central bank last year and a sell-off in Asian markets, particularly in Southeast Asia.

Six-month yields surged by nearly 3 percentage points over the past week or so, an unprecedented spell of market volatility, on heavy offshore unwinding of long bill positions as the currency weakened and the market outlook deteriorated.

Concerns of rising inflation also preyed on investors' minds, with Manila one of the rare central banks in the region to keep policy rates at financial crisis-level lows.

While much of the positions have been flushed out in the recent sell-off, local players such as banks were wary of buying them as yields still remained much below the central bank's main policy rate of 4%.

At a bill auction earlier this week, the central bank rejected all bids, an indicator that investors were demanding higher yields.

On Thursday, 6-month paper yielded 3.25% compared with 1.65% two weeks earlier and below an October high of 4.4% hit last Friday.

"Buyers will come back once yields reflect appropriate value and at these levels, they are too rich to buy, given all this talk about inflation and rate hikes," said a Manila-based trader.

December quarter GDP and January inflation data are due next week. The central bank's next rate setting decision is on Feb 10.

Beating Libor

In November last year, the central bank stopped rolling over its forward book, which caused a dollar squeeze in the money market and triggered a widespread shifting of short dollar bets out of the cash into the FX forward markets.

That led to a collapse in forward points which meant an offshore fund sitting on excess dollars could convert them into pesos, buy local bills, hedge those dollars by buying the suddenly cheap forward points and still generate a higher yield than putting them in money market funds.

Mike Garcia, first vice-president at Union Bank Philippines who manages $570 million in funds, said at one point a foreign investor could generate as much as 6% on an annualized basis on this trade.

Three-month LIBOR has averaged between 0.2840% to 0.3050% since November.

"If you take it from the point of view of the offshore guys who are trying to beat LIBOR, you are making a better trade by using these short term securities even if they were trading much below relative value," Garcia said.

But with Asian markets underperforming Western peers so far this year the party has come to an end, with yields soaring and currencies weakening, making this trade unattractive and leading to a washout of positions.

The peso has been one of the leading laggards this year, weakening by more than a percent versus the dollar so far this year to 44.15 per dollar. Standard Chartered Bank sees dollar/peso at 45 by the end of March and at 46.00 by end June.