Authored by: Justin Choi, Antonio Panis, Elijah Soriano
Edited by: Jared Go, Ethan So
Latest Economic Data
Philippine Economic Data
BSP cuts RRR by 100-250 bps
Manufacturing Purchasing Managers’ Index (PMI) expanded to 53.7, the highest since mid-2022
YoY CPI inflation decelerated to 1.9%, the lowest since May 2020
US Economic Data
Federal Reserve cuts target Federal Funds Rate (FFR) by 50 bps to 4.75-5%
YoY CPI inflation accelerated to 2.4%, higher than the expected 2.3%
Manufacturing PMI decreased to 47.3 from 47.9 in August
August Personal Consumption Expenditures (PCE) Index Inflation decelerated to 2.2% from July’s 2.5%
Other Economic Data
People’s Bank of China (PBOC) cuts RRR by 50 bps to a weighted average of 6.6%
Bank of Japan (BOJ) keeps its policy rate steady at 0.25%
Introduction
In spite of the September effect and the events last August, financial markets remained bullish and positive for both the US and Philippine market. Fueled by the Federal Reserve’s 50 basis point (bp) rate cut and the recent BSP’s 100-250 bp rate cut to the Reserve Requirement, both the S&P 500 and the PSEI remained relatively upbeat. Nevertheless, concerns regarding inflation, unemployment, and economic growth remain relevant, especially with the contractionary trend seen for the US Manufacturing PMI, alongside recent spikes in commodity prices at the end of the month and the looming US election.
Federal Reserve Rate Cut
Figure 1. Effective Federal Funds Rate
Source: New York Federal Reserve
In September 2024, the Federal Reserve announced a 50 basis points (bps) rate cut, reducing the target range for the federal funds rate to 4.75%-5% (New York Federal Reserve, 2024). This move was largely driven by the Federal Reserve’s confidence that lowering rates would support a strong labor market while ensuring that inflation will continue its decline to the 2% target without risking economic stability (Dwyer, 2024). Additionally, as a result of the rate cuts, the S&P 500 experienced a notable upward trend, reflecting an increase in investor confidence.
Figure 2. U.S. Unemployment Rate
Source: U.S. Bureau of Labor Statistics
Recent Data shows that “total nonfarm payroll employment increased by 254,000 in September, and the unemployment rate changed little at 4.1 percent” (U.S. Bureau of Labor Statistics, 2024). This shows that despite ongoing economic pressures brought about by various macroeconomic events such as tensions in the Middle East and China’s economic slowdown, the US labor market is able to stay resilient. The relatively stable unemployment rate indicates that businesses are continuing to hire. While inflation remains a concern, the Federal Reserve is making careful considerations to its monetary policies in order to balance economic growth with the goal of bringing inflation back under control.
Figure 3. Monthly Percent Change in the Personal Consumption Expenditures (PCE) IndexSource: U.S. Bureau of Economic Analysis
On inflation, the chart shows that the monthly percent change in PCE (the Federal Reserve's preferred inflation gauge) has fluctuated through 2023 and 2024, with notable spikes in January of both years. This data indicates that inflation pressures continue to persist. The recent months of 2024 suggest that although inflation has eased, price increases are still occurring, which reinforced the Federal Reserve’s focus on controlling inflation to reach its 2% target.
Figure 4. FOMC Participants’ Assessments of Appropriate Monetary Policy (As of September 2024’s Summary of Economic Projections)
Source: Federal Open Market Committee (FOMC)
Nevertheless, as shown in figure 4, the median projection of FOMC participants indicates that the FFR should be at 2.9% from 2026 onwards, signaling their confidence in inflation continuing to ease.
BSP RRR Cuts
On September 25, 2024, the BSP (2024) announced a different kind of cut than the one they previously announced last August–the Reserve Requirement Ratio (RRR). By October 25, 2024, the BSP will implement the following cuts to RRR: 250 bps for Universal and Commercial Banks (U/KBs) and Non-Banking Financial Institutions with Quasi-Banking functions (NBQBS), 200 bps for Digital Banks, and 100 bps for Thrift Banks (TBs) and Rural Banks and Cooperative Banks (RCBs). In effect, the new RRR will be 7% for U/KBs and NBQBs, 4% for Digital Banks, 1% for TBs, and 0% for RCBs.
Figure 4. RRR of the Philippine Banking System [Deposit Substitutes]
Source: Bangko Sentral ng Pilipinas
Unlike more common monetary policy tools such as adjusting the target Reverse Repurchase Rate (RRP) via open market operations (BSP, 2019), the Reserve Requirement Ratio is rarely used today, except in emerging market economies (Cantú et al., 2024). Essentially, the Central Bank mandates a fraction of a bank’s liabilities–usually deposits–must be held in reserve as cash with the Central Bank (Mishkin, 2022). Mathematically, RRR = Required Reserves/Total Deposit Liabilities. While similar requirements exist, such as Basel III Liquidity Coverage Ratio (Basel Committee on Banking Supervision, 2013), the RRR is exclusively used as a monetary policy tool rather than a risk management regulatory policy (Hemedes & Lapid, 2005). In theory, the RRR provides a direct approach for central banks to influence the money supply, as either an increase or decrease in the RRR would have a contractionary or expansionary effect respectively (Cantú et al., 2024).
In practice, the Reserve Requirement Ratio has varying degrees of nuance as a monetary policy tool. For one, due to their different nature, capitalization requirements, and financial profiles, the RRR varies depending on the financial institution (BSP, 2019). Furthermore, the implementation of RRR varies across countries, such as the type of deposits–by extension, their maturity dates–and the currency held, whether the local currency or an external currency, often the US Dollar (Cantú et al., 2024). Aside from deposits to the central bank, reserves could also be held in bank vaults or as Government Securities (Hemedes & Lapid, 2005).
More significantly, how effective the Reserve Requirement Ratio is as a monetary policy tool depends primarily on the structure and concentration of a country’s financial system and the overall development of its financial markets (Hemedes & Lapid, 2005). In countries with high concentration of banks in their financial system, alongside underdeveloped capital markets, RRR may be more effective to implement monetary policy (Hemedes & Lapid, 2005) as compared to a market-based approach such as the target RRP (Ihrig et al., 2020).
Figure 5. Reserve Requirements by Type, Maturity, and Currency
Source: Bank for International Settlements
However, one unavoidable effect of relying on RRR is the “tax on financial intermediation” (ANC, 2024). Because the central bank mandated bank deposits to be held in reserve, it is an opportunity cost in the form of foregone interest income as banks are unable to fully allocate deposits to productive, income-generating activities such as lending (Hemedes & Lapid, 2005). As a result, it distorts financial intermediation by pushing lending interest rates up while pulling deposit interest rates down. It is this “tax,” alongside the effectiveness of market-based monetary policy tools and the willingness of banks voluntarily holding deposits in reserve, which convinced central banks from advanced economies to sunset the RRR as a monetary policy tool (Ihrig et al., 2020).
For the Philippines, as early as 2005, the BSP has already researched and discussed the possibility of reducing the RRR (Hemedes & Lapid, 2005). During the 2000s and early 2010s, the BSP remained reluctant to introduce RRR cuts, fearing the still-underdeveloped state of its capital markets alongside the rapid economic growth would prevent the BSP from adequately responding to inflationary pressures (Guinigundo, 2015). However, recent BSP Governors have consistently advocated for sizable cuts in the Reserve Requirement (Diokno, 2022), the current Governor included (ANC, 2024). They believe the current monetary policy tool–adjusting the target Reverse Repurchase Rate–is effective enough to maintain the BSP’s inflation targets while still freeing up liquidity for a more developed financial market to efficiently utilize (Diokno, 2022).
Future Outlook
With a federal reserve rate cut and the BSP’s jumbo RRR cut, we can expect financial conditions both globally and locally to ease which may help stimulate economic growth. Overall, the global economic narrative has now shifted from ‘how long will rates remain high’ to ‘how fast will rates be cut.’ In order to understand this dynamic, it is imperative to keep an eye on incoming data and how they align with both market and central bank expectations.
References
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Federal Open Market Committee. (2024). Summary of Economic Projections. Federal Reserve. Board of Directors of the Federal Reserve System. https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20240918.pdf
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