On August 15, the Bangko Sentral cut its benchmark interest rates by 25 bps, marking the end of the tightening cycle that started in May 2022.
This 25 bps is a mere fraction of the BSP’s cumulative hike of 450 bps since 2022 and likely won’t be felt until early next year, as it takes time for changes in monetary policy to be fully absorbed by the system.
However, it does send a signal that the era of tight monetary policy is coming to a close, and this was enough to propel the market higher by more than 250 pts in just three days as investors pile back into equities.
The law of relative attractiveness
But why exactly do stocks go up when interest rates go down? Keep in mind that the BSP benchmark rates influences everything, including yields being offered for fixed income securities and time deposits.
Higher yields on these “risk-free” instruments is what sapped liquidity from the market over the past two years, as investors would naturally choose fixed guaranteed returns of 6% over the promise of 11-13% returns that may or may not materialize.
However, we may see funds trickling back into stocks as yields start to go down, widening the gap between risk-free returns and potential stock market gains.
The biggest winners
Property names were among the big winners of the day following the rate cut, as lower financing costs could potentially boost property sales.
Companies in capital-intensive industries like power generation and infrastructure are also expected to benefit from lower interest rates, as these capital expenditures are usually funded by debt.
Consumers can also start spending more on goods and services as their mortgage rates start to go down, fuelling revenue growth in the consumer, travel, leisure, and even telecommunication sectors.
Things would get worse before they get better (for banks)
Banks were the biggest beneficiaries of high interest rates, as net interest margins (i.e. the difference between interest paid by borrowers and the interest paid to depositors) widened to historic highs.
This margin is now set to start narrowing, which could reduce the profitability of banks in the short-term. However, demand for loans would eventually pick up as rates go lower, shifting the earnings driver for banks from margins to volumes.
A welcome development, but not a magic bullet
At this point, it is important to note that this is not a magic bullet that will give the market a sudden shot in the arm. Investors have begun pricing in this rate cut since the start of August, as evident in the movements of the property and financial subindices.
This trend will likely continue in the coming weeks and months, but we acknowledge that this rate cut is at least halfway priced-in already. We also do not expect a magical jump in economic activity, as it would take months for the rate cut to sink fully into the economy.
However, as we have mentioned before, this first cut is important mainly for its symbolism marking the beginning of the easing cycle and the market will likely continue to test new highs as the BSP’s path to easing becomes clearer.
We just got the first, but when is the next one?
We maintain our forecast that the BSP will implement two 25 bps rate cuts this year, with the next one to follow in December.
The central bank will likely hold during the October meeting to fully assess the initial effects and to allow the interest rate differential with the Fed to normalize after the US central bank cuts its rates in September.
If this 50 bps cut for the year becomes a reality, that would pave the way to our YE2024 index target of 7,355. In the unlikely event that this cut becomes the last cut for 2024, our index target would be 7,108.
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