MONEY MARKETS-Pressure builds as Manila battles bill yield surge

02/08/2011 -Selling pressure in Philippine bills subsided on Tuesday after the Treasury rejected bids at an auction the previous day, but investors remained on the sidelines as front-dated yields are well below policy rates.

A combination of a sharp selloff in Southeast Asian markets last month and the waning effects of a dollar squeeze has caused the front end of the curve to rise sharply.

Manila has repeatedly intervened this year to keep a lid on soaring yields by rejecting bids at primary auctions or awarding them selectively, a strategy that traders say could put the entire borrowing programme in jeopardy.

On Monday it rejected bids at the 91-day bill tender, saying yields offered were out of line with market rates, but bank traders said tendered bids represent a fair level of where money market rates should be. .

"It is surprising the Treasury thinks that any correction to where market rates should be is unreasonable when market yields are just trying to revert back to historical levels," said the head of fixed-income trading at a foreign bank in Manila.

Bill yields dropped sharply after the central bank stopped rolling over its forward book since November to break a rally in the peso , which caused a dollar squeeze in the money market and triggered a widespread shifting of short dollar bets out of the cash into the FX forward markets. .

That led to a collapse in forward points which meant an offshore fund sitting on excess dollars could convert them into pesos, buy local bills, hedge those dollars by buying the suddenly cheap forward points and still generate a higher yield than putting them in money market funds.

Three month bills which were trading around 4 percent before the entire dollar squeeze dropped to below 1 percent in early January as hedge funds and foreign banks swept in to exploit that advantage.

Yields have only recently begun to normalise, with three-month to one-year bill yields rising by 100 to 200 bps in the past three weeks, though they remain far below central bank's main policy rate of 4 percent.

On Tuesday, three-month bills were yielding 2.8 percent. (

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