Unexpectedly towards the end of last March The Fed changed its interest rate outlook from hawkish to dovish. How does this affect Indonesia’s bond market?
Of course this brings positive effect. This condition opens up an opportunity for the Bank of Indonesia (BI) to cut its interest rate earlier than expected, as long as domestic economic data such as inflation, current account deficit, and rupiah exchange rate show stable and supportive signals. Currently the expectation on BI’s interest rate cut is reflected by short term bonds yields’ bull-steepening moves. Short term bonds yields decline faster than the long terms, causing the spread between the two to normalize in around 50 basis points, from 10 basis points previously.
Does the inverted yield curve between 3-month and 10-month term UST indicate US’ recession?
Historically in the US, inverted yields - where long term bond yields were lower than short term yields - might indicate a recession in the next 12-24 months. But we are quite convinced that this time the concerns about US economic recession can be ignored, due to different background conditions. During the past inversions, The Fed was in the middle of interest rate hikes. In contrary, today The Fed is open to an opportunity to cut its interest in order to sustain its economy, especially as US’ election is drawing near next year. Current base case scenario suggests that US’ economy is slowing down, but is not necessarily falling into recession.
Which of the short term bonds or long term bonds will enjoy the most benefit, should BI cuts its interest rate?
Both. Short term bonds, which are more sensitive to changes in interest rates will move first with yield decline strongly affected by the expected decline of BI’s interest rate. This will then be followed by long term bonds yield decline. Initially, the yield curve will form bull steepening pattern – short term bonds yield decreases faster than long term bonds – until then forms bull flattening pattern, where long term bonds yield decreases faster than the short term bonds, resulting in a flatter yield curve.
Moving to INDON market, what is your view on USD-denominated Indonesian government bond market?
So far we have positive outlook on INDON market. Further upside potential will be supported by several factors, such as:
- Yield spread between 10 years INDON and UST at approximately 140 basis points, which is still attractive.
- Risk-on in financial market, supported by UST yield movement stability which expected to move around 2.5-2.7% until the end of 2019.
- Less pressure to the secondary market, with only one more INDON issuance for this year.
- Continuing improvement in domestic economy, which will give way to potential upgrade in Indonesia’s sovereign rating in the future.
Speaking of issuance and its target, in general how is the current supply-demand dynamic in Indonesia’s bond market?
Generally, two important factors in the movement of bond market are interest rate cycle and supply-demand mechanism. As discussed earlier, interest rate environment is quite conducive and attractive. On demand and supply, so far SBN (government securities) issuance in total has reached 40% of its target. Which means if SBSN (Sukuk – Islamic bonds) issuance is inline to its target, then SBN absorption on each auction is only IDR15 trillion. This is a lot less than Q1 2019 which was approximately IDR20-22 trillion. This means this second quarter’s supply and demand is also very conducive and potential.
On the other hand, seasonally Q2 on each year is the time when rupiah exchange rate weakens. What’s your view on this?
True, historically in the second quarter rupiah exchange rate tends to weaken, affected by seasonal factors such as dividend repatriation and the increase of import nearing Eid Al-Fitr. But as long as current account deficit is well-maintained, we expect the sentiments on rupiah exchange rate will be manageable.
One of the factors that can ‘fund’ the deficit in the current account is the inflow of funds in financial market. Therefore better sentiment towards emerging market and possibility of BI interest rate cut are expected to encourage the flow of funds into Indonesia’s financial market, and in turn will help decrease current account deficit. Also a conducive Election will also strengthen rupiah exchange rate.
Talking about the Election – besides the effect on exchange rate, how will it affect the bond market as a whole?
A conducive Election with unsurprising result will be supportive to the bond market. The elimination of political uncertainty will encourage funds inflow, both from domestic and global investors. So far we maintain our target yield for 10 years Indonesian government bond at 7.0-7.5%, and this target can still be revised lower if BI cuts the interest rate.
What investment strategy you exercise to achieve a superior portfolio performance?
We maintain IDR bond asset at tactical overweight duration – both for short and moderate duration portfolios – utilizing sentiment improvement on emerging market and interest rate cut opportunity. Furthermore we constantly monitor market liquidity and volatility to ensure our portfolio provide the optimal risk-return profile.
Seeking Seeking α is a monthly communication released by PT Manulife Aset Manajemen Indonesia (MAMI). Presented in the Question and Answer format, Seeking α is aimed at presenting the views of MAMI's forward-looking investment experts, directly before you, MAMI's professional investors.
This month we present the latest market comments from the Director & Chief Investment Officer
Director & Chief Investment Officer - Fixed Income
Ezra is responsible of fixed income investment management. Acquired Investment Manager Representative license from Capital Market Supervisory Agency and Financial Institution (Bapepam-LK) according to the decision letter of Chief of Financial Services Authority (OJK) No.KEP20/PM/WMI/2005 on February 15th 2005. Ezra started his professional career at Chase Global Funds, Boston, MA, USA and continued his career at Panin Securities and HSBC Jakarta. He joined PT Manulife Aset Manajemen Indonesia for the first time at 2003 before decided to join AIA as Head of Investment and returned to PT Manulife Aset Manajemen Indonesia on November 2011. Ezra acquired MBA title from Northeastern University, Boston, USA.
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