ECONOMIC UPDATE - Monetary and Bonds Review - Maintaining position in rising volatility

ECONOMIC UPDATE - Monetary and Bonds Review

Maintaining position in rising volatility

 

The policy rate stayed

Bank Indonesia (BI) retained its policy rate at 4.25% in the latest BoG meeting. The central bank also maintained deposit facility at 3.50% and lending facility at 5.00%. Current policy rate is believed to be sufficient to keep domestic macroeconomic stability and also support domestic macroeconomic recovery.

 

BI macro guidance

Central bank kept its eye open to watch rising global volatility due to increasing expectation of higher FFR increase in 2018. We have already seen some BI’s intervention in FX market when Rupiah reached more than Rp 13,650/USD this month, trying to keep Rupiah below Rp 13,700/USD. On domestic side, saw that domestic macroeconomic was getting better as the GDP growth reached 5.19% in 4Q17, driven by investment and export. Besides, inflation remained manageable at 3.25% in January even though there was an increasing risk from volatile food component, especially rice. Bank Indonesia also had a wider CAD forecast (2.0% - 2.5% of GDP) than Bloomberg consensus (1.9% of GDP) but still in line with our forecast at 2.1% of GDP due to better domestic demand which triggered higher import. However, central bank still pointed out weak banking intermediary role as showed by low credit growth in 2017. Bank Indonesia has 10.0% - 12.0% of credit growth target this year and it may initiate more macroprudential policy if the target is not reached.

 

More FFR hike expectation increase global volatility

Since US tax reform was signed at the end of Dec 2017, US bonds market turned into bearish period on the awakening expectation of better economic growth in US and higher budget deficit from tax reform. Better wage data in the beginning of Feb-18 increased expectation that The Fed may hike FFR more than three times. Currently, US 10 year gov’t bonds yield is already approaching 2.9% (YE 2017: 2.4%), even higher than our initial forecast in year end 2018 at around 2.85%. We see that US 10 year gov’t bond yield may reach 3.0% in year end. According to the latest World Economic Outlook (WEO), IMF projects US economic growth at 2.7% in 2018, higher than its previous forecast without considering tax reform at 2.3%. Heating up inflation in 2018 may make The Fed to increase FFR at 4 times in this year even though we still need to see further FOMC stance in the policy projection further in the next meeting in March when it is expected to increase the FFR for the first time in 2018.

 

Indonesia bonds market may not have another bullish period due to global trend

Higher US yield started to affect Indonesia bonds in the end of January, after it had bullish period due to Fitch rating upgrade. Indonesia yield had constantly increasing in February, especially after global volatility escalated due to US wage data. 10 yr bonds yield already reached 6.45% as of Feb 19 from its lowest position in Jan 2018 at 6.13%. We see that Indonesia bonds market will follow bearish trend of US market. Our Indonesia yield model revealed that Indonesia bond yield is highly correlated with US yield, even it is more significant than Indonesia’s policy rate, inflation and CDS (credit default swap). Furthermore, we expect BI 7 days reverse repo rate to stay at 4.25% in 2018 and start to increase following global tightening trend in 2019 to 4.75%. Inflation is expected to slightly ease at 3.5% from 3.61% in 2017 while we expect Indonesia’s credit default swap (CDS) to be stable as rising global volatility can be accommodated with increasing Indonesia’s macroeconomic performance.