Macro Strategy

Facing the Headwinds

 

• The conflation of reflation risk and the depreciation of key DXY basket currencies has sparked market volatility, necessitating caution.
• Various indicators point to strong U.S. economic resilience, which could decelerate the pace of Federal Funds Rate cuts.
• Indonesia's new government has introduced several novel initiatives focused on stimulating growth, though risks to execution remain.

 

The conflation of two risk factors. The recent surge in the U.S. Dollar Index (DXY) to >104 and the rise in U.S. Treasury yields can be largely attributed to the interplay of two main factors: reflation risk, which may slow the pace of rate cuts, and the depreciation of key DXY basket currencies, particularly the Euro and Canadian Dollar. Reflation risk is influenced by factors such as China’s stimulus measures, escalating Israel-Iran tensions, the resilience of the U.S. economy, and increased odds of a Trump election win. On the currency front, the Euro, Canadian Dollar, and Yen—significant components of the DXY—have collectively depreciated by about 3.5% over the past month. Recent rate cuts by the European Central Bank (ECB) and the Bank of Canada (BoC) are underpinning such trend, with the BoC’s recent notable 50 bps reduction signaling a pivot toward supporting growth following inflation control, and the ECB preparing for further cuts amid economic slowdowns in some EU countries. In our view, the current strength of the DXY is likely to be more constrained, particularly with the upcoming FOMC meeting scheduled for early November, where a rate cut is widely anticipated. This could balance out the playing field, potentially easing dollar strength and fostering currency balance. However, a hawkish stance by the Fed in Nov meeting could keep the USD elevated, raising the risk of increased IDR volatility and limiting Bank Indonesia’s room for rate cuts.

 

US Economy: Indicators of Hard, Soft, and No Landing. The trajectory of U.S. economic growth remains balanced, complicating disinflation efforts, especially with external reflation risks in play. Multiple indicators suggest economic resilience that could slow the pace of Federal Funds Rate (FFR) cuts:

1. The Fed's recent Beige Book points to economic moderation without signs of contraction, with consumers continuing to spend despite high prices, bolstered by optimism around potential rate cuts. Although uncertainty remains high, contacts have expressed somewhat greater optimism about the long-term outlook. Many districts also reported low worker turnover, with limited layoffs (Exh. 2).
2. The Atlanta Fed’s GDPNow model recently raised growth forecasts to 3.4%, above the 3% consensus, reflecting U.S. economic resilience and supporting gradual rate cuts, provided this week’s initial 3Q24 official U.S. GDP report confirms the trend.
3. The Dallas Fed's Weekly Economic Index, tracking weekly consumer and business activity, still shows positive growth year-to-date. However, recent data indicates some moderation, with the index falling to 1.69 as of October 19, down from a 21-month high of 2.66 in early July 2024.

As the U.S. election draws nearer, market sentiment is increasingly leaning toward a possible Trump victory, with Harris maintaining a slim lead in polls and electoral forecasts that either remain close or tilt toward Trump. A Trump administration is expected to expand the federal budget deficit more than a Harris administration, potentially impacting international relations and increasing future uncertainties. This rising deficit heightens fiscal dominance risk, as evidenced by the growing Treasury Term Premium on the 10-year U.S. Treasury, along with an uptick in the 10-year Breakeven Inflation Rate (refer to Exhibit 6), necessitating caution.

 

The New Indonesian Government Initiatives. Several major policy initiatives have been announced, with the new government prioritizing growth stimulation. A key challenge lies in balancing the need to increase tax revenue without overly impacting consumption, while ensuring targeted spending on areas with high growth multipliers. The main proposals include a potential corporate tax reduction, adjustments to the goal of developing 3 million housing units annually, and a “whitening” policy to clear credit histories for repaid debts:

1. Our analysis suggests that reducing the corporate tax rate from the current 22% to 20% could lower government revenue by up to IDR 50 trillion if not offset by other measures, potentially raising the fiscal deficit by 0.2 percentage points, from the budgeted 2.5% to 2.7% in 2025. However, this impact may be partly mitigated if businesses increase output, as lower tax costs could support the capital expenditure cycle, benefiting banking intermediaries and fostering job creation.
2. The housing initiative aims to develop 3mn units annually, with 2mn allocated to local developers to encourage balanced regional growth.
3. The debt “whitening” program seeks to clear negative credit records for 6mn debtors, including MSMEs, farmers, and fishers, allowing them renewed access to loans and potentially stimulating the lower-to-middle-income economy.

On the risk side, we note that rapid execution of the initial agenda may be slowed by changes in ministerial structures due to cabinet expansion. While early momentum is often anticipated within the administration’s first 100 days, substantial progress could take longer unless these structural changes are finalized by year-end. On the “whitening” program, banks will still manage loan approvals and may adopt a more cautious, risk-averse approach if the policy extends to new loans, potentially slowing loan growth and increasing credit costs due to elevated risk.

 

Capital Market – Higher Yield and Currency Volatility. The 10-year U.S. Treasury yield rose to 4.25% by October 25, marking a 22 basis point weekly increase. Likewise, the 2-year U.S. Treasury yield grew by 16 basis points to 4.11%. The 10-year Indonesian Government Bond (INDOGB) yield also saw an uptick, climbing by 8 basis points to 6.75% last week. The U.S. Dollar Index advanced by 0.55% on a weekly basis, while the Indonesian Rupiah weakened by 1.13%, closing at IDR 15,640. Indonesia’s 5-year Credit Default Swap (CDS) remained steady at 69 basis points as of the same date.

 

Fixed Income Flow – Continues foreign inflows, while Banks reduce position. Despite recent volatility, foreign investment in domestic Government Securities (SBN) experienced a slight inflow of IDR0.04tn last week (as of 24 Oct), bringing total foreign holdings to IDR 889tn. Month-to-date (MTD), foreign inflows reached IDR18.78tn. With still robust foreign demand, the banking sector continues to reduce position with weekly outflow of IDR5.48tn, contributing to a larger MTD outflow of IDR33.16tn. Bank Indonesia (excluding Repo transactions) reported a weekly inflow of IDR4.72 tn, though MTD figures showed a marginal outflow of IDR0.37tn. Mutual funds recorded a weekly inflow of IDR1.23tn, while the insurance and pension fund sectors observed inflows of IDR3.33tn.

 

Equity Flow – Turned into outflows. Foreign outflows in the 4th week of Oct totaled IDR1.7tn with JCI down 0.8% last week. Year-to-date (YTD) outflows in the regular market reached IDR1.9tn. On a weekly basis, BBNI, INDF, UNTR, AMRT, and EXCL consistently ranked among the top inflows. ASII led the inflows after two consecutive weeks of outflows, boosting its share price performance by 6.2%. GOTO and ANTM were also among the major inflows. On the other hand, BBRI, MDKA, INKP, and KLBF consistently ranked among the top outflows.

 

… Read More 20241028 MacroStrategy