Macro Strategy: Ominous Carry Trade Unwind Risk

Stock Code	Last Price	Change	Change %
TPIA	8.625	750	9,52%
DSSA	46.175	675	1,48%
CITA	4.040	560	16,09%
LIFE	6.550	550	9,17%
ADES	11.600	500	4,50%
CUAN	7.600	475	6,67%
CBDK	7.150	450	6,72%
KONI	1.635	325	24,81%

Macro Strategy

Ominous Carry Trade Unwind Risk

The Bank of Japan's plan to halve its bond purchasing program will be crucial for the Yen, triggering concern about carry trade unwind risk.
While not entirely immune, Indonesia's impact should be manageable due to its low foreign position and minimal Yen-denominated debt.
Despite recent positive economic data, Fed rate cut expectation in Sept remain firmed. BI will also limit the issuance and ownership of SRBI

Risk of Yen Carry Trade Unwind. This week could be a pivotal moment for the Bank of Japan (BoJ) as it is expected to announce plans to halve its bond purchasing program, which currently stands at JPY6tn/month (~USD40 bn). The goal is to gradually reduce the monthly purchase to JPY3tn over the coming years. This move to reverse its massive monetary stimulus has been a key missing factor in recent months, contributing to the Yen's weakening.

BoJ March’s rate hike had little impact, as the JPY continued to depreciate against the USD, reaching decade lows. The market is uncertain if this week's meeting will include another rate hike, as it would be too much of a contractionary policy at once, although another rate hike is expected to happen again sometimes this year. A combination of these contractionary policies would lead to ripple effects, particularly on the unwinding of JPY-funded carry trades. The USDJPY began reversing its long uptrend after weak US June CPI data, partially due to an alleged intervention. Recently, the JPY has strengthened significantly against the AUD and NZD, gaining 8-9% in the past two weeks, with momentum increasing since last Thursday. This could potentially signal the beginning of carry trade unwinding. The JPYIDR has shown a similar trend over the same period.

The Key Impacts. With JPYIDR breaking its multi-year resistance, the risks for the carry trade increase, potentially leading to further unwinding and resulting in foreign outflows. We highlight three key typical risks that might arise from the unwinding of the JPY carry trade: 1. Rising Market Volatility: The unwinding of the carry trade involves investors selling higher-yielding assets and such significant selling pressure on these foreign assets can lead to large market movement, as indicated by the rise in the VIX over the past two weeks; 2. Liquidity Contraction: The unwinding of carry trades can impact funding liquidity in financial markets, and lead to tighter liquidity conditions. Increased risk aversion would prompt a flight to safety, leading to market instability; and 3. Growth & Monetary Policy: A stronger JPY affecting global inflation and influencing monetary policy decisions. Since the JPY has been used to fund many carry trades, its appreciation would have a ripple effect across many economies.

For the Indonesian market, while volatility risks would still persist, it's still inconclusive whether JPYIDR alone carries significant magnitude given:

The overall foreign flow has been relatively low, with foreign outstanding positions at IDR800tn (14% of total issuance). Historically, this level has been relatively stable, as investors mostly hold INDOGBs as reserves or long-term investment assets.; 2. Data from Japan’s MoF indicates that Japan’s own portfolio investment in Indonesia is relatively small compared to the overall foreign flow. Total Yen-denominated debt for private and public debt is also relatively insignificant, and 3. BI has ample ammunition for intervention. Through SRBI’s issuance, Bank Indonesia has raised c. IDR800tn in proceeds vs net addition of BI’s govt bond of IDR497tn since the start of SRBI, partly to stabilize yields. Hence, we believe there is still ample ammunition for intervention in the event of foreign outflows were to intensify, maintaining market stability.

Fed’s Rate Cut Intact Despite Recent Positive Data. Stronger-than-expected US GDP and PCE data did not deter the market from expecting 2-3 rate cuts this year. The USD 2Q24 GDP growth continues to remain robust at 2.8%, higher than the consensus expectation of 2%, with consumer spending accelerating to 2.3% from 1.5% in Q1. The Core PCE, the Fed’s preferred inflation gauge, rose 0.2% m-m, exceeding the estimate of 0.1%. Despite these strong figures, the market seems to recognize the ongoing economic moderation. The three-month annualized Core PCE softened to 2.3%, the lowest in 2024, which bodes well for this week's FOMC meeting (31^st July).

Given the recent economic moderation, Fed could cautiously signal the start of rate cut cycle, which would support the case for bull steepening, where the 2-year UST yield declines faster than the 10-year, a pattern observed in 1990-92, 2001, 2003, 2008, and 2020. The term "bull" refers to the rally in the bond market, while historically the equity market could potentially slow due to lagging earnings performance.

Preventing Market Disharmony – competition for liquidity. Domestically, Bank Indonesia might limit the issuance and ownership of SRBI. As SRBI has effectively replaced Reverse Repo, it is now the primary contractionary tool for BI’s OMO to control liquidity. SRBI issuance has been able to lure IDR 280tn of foreign inflow, accounting for approximately 30% of the total SRBI outstanding. Domestic non-bank ownership has also seen a significant increase in the last two months. As of July 19th, domestic non-banks hold IDR 54.3tn, or 6.8% of SRBI outstanding, with pension funds and insurance holding IDR41tn of it, up from mere IDR60bn at the end of 2023. With SRBI focused on attracting foreign inflow, sales to retail investors (which have been conducted by banks in recent months), pension funds, and insurance companies potentially would be restricted, party to prevent further market disharmony due to competition for domestic liquidity, including from fiscal and banking. We expect these restrictions to take the form of maximum ownership limits, mirroring the minimum ownership requirements applied to SBN. These restrictions would support sustainable SBN growth and reduce borrowing costs for companies (corporate bond yield), which have remained high due to SRBI yields.

Capital Market – Foreign Inflow Momentum Start to Dissipate.

The yield on the 10-year US Treasury bond further down 5 bps to 4.20% last week with the 2-year US Treasury bond yield declined even more by 13 bps to 4.36%, maintaining the recent trend of bull steepening. In contrast, the yield on Indonesia's 10-year government bonds (INDOGB) increased by 4 bps to 6.99%, given foreign flows momentum recede. The DXY experienced a slight depreciation of 0.02% over the week, with the Indonesian Rupiah weakened by 0.62%, closing at IDR 16,290 per US dollar. Conversely, Indonesia's 5-year credit default swap (CDS) spread narrowed by 3 basis points to 74 basis points during the same period.

Fixed Income Flows - Foreign ownership of domestic Government Securities (SBN) decreased by IDR 3.65tn with overall outstanding falling to IDR 808.51tn (as of July 23 data). However, on a month-to-date basis, there was an inflow of IDR 0.41 trillion. In contrast, the banking sector reported an inflow of IDR 16.89tn over the same period, despite MTD outflow of IDR 59.82tn. Bank Indonesia (excluding Repo) recorded an outflow of IDR10.27tn vs MTD inflow of IDR35.29tn. Mutual funds saw weekly inflow of IDR1.13tn, while insurance and pension funds experienced an inflow of IDR3.40tn.

Equity Flows - Foreign inflows in the 4th week of July 2024 amounted to IDR161bn, while JCI performance declined by 0.1% wow. YTD 2024 outflow in the regular market amounted to IDR13.7tn. On a weekly basis, BBCA, AMMN, ISAT, and ADRO continued to rank among the top inflows. Conversely, BBRI, GOTO, BBNI, BRPT, and BREN consistently ranked among the top outflows.

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