Philippine government bonds are the most exposed in emerging Asia to a hawkish US Federal Reserve, according to a Bloomberg analysis, having fared the worst in the region during each of the last two American tightening cycles.

The country's sovereign debt lagged all regional peers during the two most recent Fed tightening episodes, which began in 2017 and 2022. Philippine 10-year yields climbed by an average of 152 basis points across those periods — nearly four times the increase recorded in India, the region's second-worst performer. The gap shows how heavily the region's Fed-related risk is concentrated in a single market.

This year's selloff has been driven by surging energy prices and rising US Treasury yields, while a strengthening dollar has lured funds away from peso-denominated assets. The prolonged conflict involving Iran is adding to the pressure on Philippine sovereign debt by keeping oil prices and inflation elevated.

"Higher US yields could continue to exert upward pressure on Philippine bond yields, particularly at the longer end, while also weighing on the peso," said Rong Ren Goh, a fixed-income portfolio manager at Eastspring Investments in Singapore. He cited additional headwinds including "persistent inflation, peso weakness and uncertainty" over where the Philippine central bank's policy rate will ultimately settle.

Dollar-based investors in Philippine bonds have lost more than 11% this year through Thursday, according to data compiled by Bloomberg, while an equivalent gauge for Asia as a whole has gained 3.1% — a divergence that reflects both the bond selloff and the peso's slide against the dollar.

Fed Chairman Kevin Warsh signaled on Wednesday that the central bank remains on course to raise interest rates again this year, even as he maintained his refusal to offer explicit guidance on the future path of policy.

The peso has weakened about 8% against the dollar this year, making it Asia's worst-performing currency after the Indonesian rupiah. That depreciation is compounding pressure on Bangko Sentral ng Pilipinas to tighten further, following last week's bigger-than-expected 50-basis-point rate increase.

"Currency stability has become an important consideration in the policy reaction function, complementing the BSP's efforts to contain inflation expectations," said Peerampa Janjumratsang, a fixed-income portfolio manager at M&G Investments in Singapore. Combined with risks from the El Niño weather pattern, she said the central bank "may retain a hawkish bias despite the weaker growth backdrop."

Indonesian bonds were historically the region's most sensitive to Fed policy shifts, but Bank Indonesia's debt-purchase program, launched in 2020, appears to have blunted some of the impact of US rate hikes. The central bank's ownership of outstanding government bonds climbed from around 10% at the start of 2020 to a peak of roughly 27% in January 2023 — a shift that suggests domestic policy tools, as much as Fed policy itself, now shape how the region absorbs US tightening.

Citigroup Inc. strategists including Gordon Goh wrote in a note last week that investors should remain cautious on Philippine bonds given a "backdrop of elevated energy prices and El Niño risks." "Risks in the current environment are skewed heavily towards a more hawkish BSP," they added.

What happens next in Philippine bonds will hinge on the variables the analysts themselves flagged: whether the Fed follows the course Warsh described with another hike this year, how the BSP weighs currency stability and inflation against a weaker growth backdrop, and whether elevated energy prices and El Niño risks persist.

Source: BusinessWorld — Bloomberg