Macro Strategy

Unraveling The Reset

 

• US-China “Total Reset” deal brough significant relief to global economic specters, although rising short end yield signal lesser rate cuts.
• We observe the 4 factors to assess BI’s potential imminent rate cuts, with more factors points to rate cut, aside from rising swap cost.
• The current economic moderation could be prolonged, requiring an integral approach to fiscal and monetary counter-cyclical policies.

 

US – China “Total Reset”: Our view. The trade war de-escalation between the US and China, marked by a 90-day suspension, has eased recession concerns and provided relief to global markets. We highlight two critical elements: (1) Donald Trump declared a “total reset” in US–China relations, signaling a willingness to cooperate and a complete reversal from his earlier stance; and (2) Treasury Secretary Bessent noted that “neither side wants to decouple,” offering some reassurance of reduced tensions going forward.

As part of the truce, both sides will temporarily reduce tariffs, though original Trump-era tariffs remain in place with China will reduce tariffs on US goods from 125% to 10%, while the US will lower tariffs on Chinese goods from 145% to 30%.  In our view, while the announcement brought immediate relief to markets, historical precedent still urges caution. A similar 2018 truce also paused tariffs but proved futile, leading to the 2020 Phase One deal.

 

Following the deal announcement, the US dollar rallied, with the DXY index rising above the 101 level, marking a one-month high. US equities also surged, reflecting a renewed “risk-on” sentiment, at the expense of rising UST yields. While the temporary tariff relief may ease short-term inflationary pressures, the upward move in the short-end UST yields suggests that markets now anticipate lesser FFR cuts of only two cuts, considerably lower than five cuts expectation on the onset of liberation day tariff announcement. In the latest FOMC, while inflationary risks remain elevated, Chair Powell’s acknowledgment of the Fed’s limited ability to counter tariff-driven price increases suggests that a rate hike is unlikely, regardless of whether the price shocks prove transitory or more persistent. Instead, the Fed may be compelled to respond to softening labor market conditions and broader economic weakness, even in the face of above-target inflation.

 

Assessing the rate cut possibility on 4 factors. Domestically, the challenge lies in balancing growth and stability, especially given Indonesia’s continued growth moderation. We assess the key driver for BI’s rate cut through four key factors: (1) weakening macro indicators that echo past slowdowns, (2) ongoing contraction in manufacturing as reflected in PMI and GDP data, (3) net liquidity injections from SRBI maturities and BI’s bond purchases, and (4) rising swap rates and constrained domestic USD supply. In our view, while the recent increase in swap costs and limited foreign currency liquidity remain key risks that could constrain BI’s rate policy option, the first three factors support the case for a more imminent rate cut.

 

1. Weak Macro. We reiterate our earlier report “In Search the Parallels” (17^th Mar) highlighting the similarities between current macro conditions and the 2015–2016 period: Government Transition Period, Weak Consumption trend, Supply-Side Slowdown with Manufacturing growth stalled, Loan Growth Moderation and Money Supply Decline. In response to such conditions in the past, both the government and Bank Indonesia (BI) took counter-cyclical steps, including fiscal stimulus and monetary easing. These historical parallels may signal a policy pivot ahead if growth continues to underperform.

 

2. Manufacturing Weakness (PMI): Indonesia’s manufacturing PMI has fallen below the 50 mark, indicating contraction and continuing a negative month-on-month trend. Given that manufacturing is the largest contributor to GDP, its decline often signals broader economic weakness. Historical trends show that when PMI stays in contractionary territory, central banks typically respond with policy easing to prevent a deeper slowdown. This is further supported by 1Q25 GDP data, which showed non-oil & gas manufacturing growth falling to a three-year low which also below its pre-pandemic average. Together, these indicators reinforce the case for a preemptive rate cut to stabilize growth expectations. Furthermore, since the inception of the 7DRR regime, BI has tended to be more responsive to weaker PMI data when considering rate cuts.

 

3. Net liquidity injection from OMO. Over the past five months, SRBI maturities have consistently outpaced new issuances, resulting in a net injection of liquidity into the financial system. In May 2025, total SRBI maturities amount to IDR118tn, with IDR80tn still set to mature over the remainder of the month. The last comparable maturity event occurred in Jan25, when BI issued only IDR85tn, effectively injecting IDR30tn into the system. Should the current issuance trend persist, a similar liquidity boost is likely. In the SBN market, BI has also continued to increase its holdings, with its ownership rising by IDR18tn MTD and IDR45tn YTD, further reinforcing the accommodative stance.

 

4. Rate Indicators – Swap rate and USD supply: Swap rate have risen notably in recent months, even as the interest rate differential has remained relatively stable. Historically, such increases are typically linked to widening rate differentials, while periods of rate cuts (like in 2016–17 and 2019) or a less hawkish Fed in 2022 have corresponded with declining swap costs. Between late 2022 and early 2024, swap costs were unusually low despite high trade surpluses, which likely discouraged full USD-to-IDR conversion. Many USD holders opted to use derivatives instead, resulting in weak growth in domestic USD supply (proxied by foreign currency-denominated deposits) relative to M0 (Monetary Base) expansion. This led to an elevated M0/USD supply ratio. Since early 2024, the trend has reversed: swap costs have climbed, the trade surplus has narrowed, and the M0/USD ratio has begun to normalize. Although external risks continue to be the primary driver of the IDR, the improved domestic USD liquidity should help support near-term currency stability.

 

Growth Risks Persist Without Policy Intervention. The 1Q25 GDP print came in largely in line with our projection and market consensus, both anticipating growth close to 4.9%. On the expenditure side, the subdued household consumption, despite the expected seasonal boost from Ramadhan, raises concerns about underlying consumer strength. The contraction in government spending was anticipated, reflecting the impact of budget efficiency measures. Looking ahead, the absence of seasonal drivers in 2Q25 and a high base from Ramadhan and Lebaran in 2Q24 suggest it will be challenging for GDP to exceed 5% without the support of temporary social assistance or other pro-growth fiscal interventions.

 

On a sectoral basis, the strong contribution from agriculture, primarily due to the harvest season, further highlights the unsustainability of current growth levels under a “business as usual” policy framework. Growth in higher value-added secondary sectors like manufacturing is often viewed as a sign of economic advancement, typically associated with rising income per capita and progress toward developed country status. As such, major intervention is needed to counter the current weak cyclical, both on fiscal policies (stimulus and investment deregulation) and monetary (rate policy and liquidity).

 

Capital Market – Tarriff de-escalation led to rising yield, with equity surges. US Treasury yields edged higher, with the 10-year rising 4 bps to 4.37% and the 2-year up 5 bps to 3.88%. End of last week, Indonesia’s 10-year government bond (INDOGB) yield closed lower 2 bps to 6.86%. The DXY gained 0.35% on a weekly basis, while the IDR weakened by 0.49% to IDR 16,515. Indonesia’s 5-year Credit Default Swap (CDS) narrowed by 6 bps to 90 bps, reflecting a modest improvement in perceived sovereign risk.

 

Fixed Income Flow - Foreign inflows into Government Securities (SBN) have continued to gain momentum, with net purchases reaching IDR7.16tn MTD, lifting total foreign holdings to IDR907tn. On YTD basis, foreign investors have added IDR30.18tn in net inflows. Domestically, the banking sector recorded MTD inflows of IDR2.82tn, bringing its YTD total to IDR83.49tn. Bank Indonesia (excluding repo transactions) saw the largest MTD inflow of IDR18.40tn, contributing to YTD inflows of IDR44.99tn. Mutual funds and insurance/pension funds also maintained steady demand, with MTD inflows of IDR2.37tn and IDR3.45tn, respectively.

 

SRBI Flow - The money market instrument continued to experience foreign outflows, which we believe driven by reduce issuance from BI. Outstanding SRBI declined by IDR15.76tn to IDR866.05tn as of 9 May. Last week, foreign net outflows recorded at IDR3.75tn, which brings total YTD foreign outflows in SRBI to IDR15.85tn, with foreign ownership now accounting for 23% of the total, or IDR199 tn.

 

Equity Flow - The JCI rose 0.3% last week, closing at 6,832.8. In the first week of May (5–9 May), foreign investors recorded net outflows of IDR1.7tn, bringing the YTD outflow to IDR36.2tn. Meanwhile, foreign investors consistently accumulated positions in ANTM, BRIS, AADI, ISAT, and EXCL, while BMRI, BBNI, PNLF, UNTR, and BBRI experienced foreign selling.

 

… Read More 20250514 Macro Strategy