U.S. yield curve near the widest in over a year

- Most U.S. yield curves have flattened in recent months in tandem with a similar move in Southeast Asian Treasuries. The Philippines is an outlier.

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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 longer end of the curve while elevated inflation weighs on short maturities.

The steeper curve could mean higher funding costs as the deficit grows to a record 9.3% of gross domestic product this year, although Treasurer Rosalia 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 inflation risk premium, said Duncan Tan, a strategist at DBS Bank Ltd. in Singapore. As long as energy prices stay supported, we expect regional bonds to underperform and the yield curve to steepen relative to Philippine curves. The spread between five-year and 10-year Philippine bonds stands at 117 basis points. It reached 132 basis points in late September, the widest in over a year.

In contrast, the Malaysian and Thai yield curves have narrowed by 21 basis points and 17 basis points, 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 U.S. 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 basis points from 49 in a year s time.

The Philippine curve may also steepen further as higher price pressures drive 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 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 likely 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 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.

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