USD/PHP Rebound Tests 61.70s; Oil, Fed Policy Weigh on Peso

The US dollar rallied about 0.6% against the Philippine peso in July, pushing the pair back toward the highs near 61.70 to 61.80. The dollar rose from around 61.50 in late June to test the 61.80 handle this week, a level not seen since early in the year. The rebound followed a 0.2% dip in June. Traders said the dollar found support from a repricing of Federal Reserve rate expectations under Chairman Kevin Warsh and from rising crude oil costs that are swelling the Philippines' import bill. The pair is up about 3% from its April low near 60.00. The peso is the second-worst performing currency in Asia this month, behind only the Japanese yen, according to data compiled by Bloomberg.

The shift in expectations was abrupt. In May, the market priced two to three quarter-point cuts by December. By late June, those bets had been abandoned. By July, some traders were pricing a small probability of a hike, traders said. Inflation has stayed above the Fed's target, and Warsh's early statements have signaled a willingness to tighten further if needed, traders said. A softer-than-expected July CPI report briefly pushed those hike bets off the table. The peso gained about 0.4% on the day of the release. The relief did not last. Two weeks later, the dollar had recovered all of that ground and more, the traders said.

Crude oil prices climbed after Middle East tension escalated, widening the Philippines' trade deficit. Brent crude traded near $85 a barrel in July, up from $75 in June. The country imports most of its fuel. For the Philippines, every $5 rise in oil adds roughly $1.5 billion to the annual import bill, according to estimates cited by Manila traders. The steady bid for dollars in the spot market creates a consistent weight on the peso, the traders said. The peso's correlation with Brent crude has strengthened to 0.7 over the past month, up from 0.4 in the first quarter, the traders said.

The Bangko Sentral ng Pilipinas raised its policy rate to 4.75% to combat imported inflation. The rate is among the highest in Southeast Asia. The Fed's firm stance keeps US yields elevated and draws global capital into dollar assets, the traders said. The narrow spread between the BSP's rate and the Fed's 5.25-5.50% range limits the carry appeal of the peso, the traders said. The BSP could hike again. Doing so risks slowing domestic growth, which is already under pressure from high fuel costs and weak export demand. A rate hike would also widen the interest rate differential with the Fed. The carry trade appeal of the peso is limited by the country's current account deficit, traders said. The current account deficit is expected to widen to 3% of GDP this year, driven largely by the oil import bill.