Macro Strategy

Shift in Rate Trajectory

 

  • Signs of volatility easing on de-escalation of geopolitical tensions, but the recent rising energy prices underpin the higher-for-longer narrative.
  • While BI intervened in forex markets, we see no sign of further BI monetary contraction to support the IDR, with OMO falling further.
  • We alter our yield projection on the higher-for-longer narrative. The recent yield and IDR levels provide room for foreign inflows.

Not Out-of-the-Woods yet. Despite efforts from both Israel and Iran to downplay the conflict, we expect the ongoing geopolitical tensions to continue to keep market volatility high. However, there are some signs of volatility easing: 10- yrs US Treasury yields slightly down to 4.62%, and Brent crude has stabilized at USD86/bbl after a brief spike to USD90/bbl. Nevertheless, the possibility of crude oil falling below USD80/bbl in the near future seems unlikely. Historical patterns suggest that heightened geopolitical tensions tend to drive up energy prices (refer to Exhibit 8-9 for details), which could disrupt the narrative of disinflation and deter rate cuts. The latest US beige book indicates a continued robust economic environment (Exh. 11 for details), whereby this trend is supported by recent hawkish comments from FOMC members, who suggest that there is no urgency to propose rate cuts and that maintaining the current restrictive policy stance for a longer period is appropriate. The market has already factored in this scenario, as the first rate cut is now expected in September, with only 2 cuts expected during the year, considerably more conservative compared to 6 cuts expectations back in early 2024.

 

BI Rate to Stay Unchanged? The current weakening IDR has spurred expectations of another BI rate hike, though we don't believe it will be the ultimate solution for stabilizing IDR. Initially, we anticipated BI intervention in the spot and DNDF markets, along with monetary policy tightening through the absorption of IDR from the system to reduce IDR supply. However, the latter seems to be minimal, as evidenced in the latest SRBI auction where only IDR3.5tn was awarded to investors, marking the fifth lowest awarded amount out of 47 auctions conducted so far. BI seems to be maintaining its yield curve, as indicated in the average awarded yield of 6.84% (<1-year INDOGB yield), on the lower range of investor bids range of 6.75% to 7.60%. Overall 4 weeks-avg OMO also declined further to IDR704tn, 5% lower than last month's level, despite current market liquidity being greater than in Oct 2023 (when the last BI rate hike took place). While this milieu raises the likelihood of a rate hike, the further de-escalation of geopolitical risks and more stable DXY provide BI with the option to further optimize its monetary tools while refraining from rate hike.

 

Higher-for-Longer. With rate cut expectations now delayed to 4Q coupled with fewer rate cuts this year, we alter our yield forecast to 6.26 – 6.98% from 6.15 – 6.6% previously. Our base case for the 10y INDOGB yield is 6.6% with BI expected to cut rates by only 25bps in 4Q24. Presently, the IDR and yield are likely to remain elevated given a lack of real positive catalysts coupled with persistent outflows. The absence of foreign inflows so far this year, however, could potentially be reversed given the attractive yield and IDR level, providing foreign investors with the opportunity to enter. Such foreign inflows would underpin IDR strengthening to IDR15,800/USD by the end of the year. Looking at the government’s fiscal base assumptions, the IDR, ICP, and 10y INDOGB yield are already above the base assumptions. This consequently results in a higher deficit of IDR91tn and further hampers fiscal stability risk, which would warrant more caution.

 

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