10 year and 2 year US government bond yield inversion – which the 2-year bond yield is higher than the 10-year – is considered a signal that predicts recession. What is your view on this?
This yield inversion phenomenon is indeed the market’s main focus lately. Nine recessions that happened in US in the last 60 years were always preceded by 10-year and 2-year yield inversion. Therefore the market assumes that yield inversion is a signal that recession will happen. But in our opinion, it is too early to conclude that global economy will face recession based on yield inversion only. In previous periods, yield inversion occurred on average for around 2 months. However currently the inversion only occurs for days as of yet, therefore we can’t consider the yield inversion as a strong signal of recession just yet.
Besides, the current global economic condition is quite unique compared to before. In the midst of low interest rate environment, about 30% of global government bonds offer negative yield. While US government bond still gives positive yield, and therefore it encourages inflow of funds to US bond market and gives pressure to lower US government bond yield. In our opinion this condition “distorts” US bond market which makes yield inversion not a definitive signal of recession.
US and China trade tension increased again last August with the two countries applying additional tariffs on each other. What is your view on global economic growth amidst this condition?
The increase in US-China trade tension is certainly not positive news to the business world and financial market. The uncertainty caused by prolonged high trade tension can have negative impact on global trade and manufacturing sector. On the positive side, global economy is still sustained by service sector that still shows growth. Global service sector PMI index was on 52.5 on July which indicates expansion. Strong labor sector with low unemployment rate, and healthy wage growth manage to sustain the consumer purchasing power and support growth of service sector.
Going forward we expect global central banks and governments will be more accommodative to mitigate the risk of economic slowdown. With this backdrop, we will re-enter the era of low interest rate for longer. But not only from the interest rate’s side, the government will also become more accommodative by preparing fiscal stimulus to support the economy. Recently the governments of Germany, Thailand, and South Korea stated that they can issue stimulus if needed. We think these proactive and pro-growth central banks and governments policies will help to support global economy in the midst of trade war uncertainty.
With the global economic condition that you mentioned, what are the impacts on Indonesia?
Indonesia is a domestic oriented economy. Our export is only 17% of GDP, relatively small compared to our neighbors such as Malaysia and Thailand whose exports are more than 50% of GDP. Therefore Indonesia’s economy is relatively more protected in the middle of the current global economic slowdown.
Instead we see an opportunity for Indonesia in the midst of US-China trade war, if the government can act swiftly. Currently there are many global companies that start to diversify their production bases to other countries besides China to minimize the risk of tariff and other protectionist policies. The government can use this opportunity to entice foreign companies to invest in Indonesia and make Indonesia a production base for export. This development can become a new source of growth for Indonesia and reduce Indonesia’s dependency on commodity export, and in the future can help to maintain current account deficit and Rupiah exchange rate.
We see that the direction of government policies is on the right track to attract foreign investment through the efforts to simplify the procedure of doing business in Indonesia. Recently the government also issued a new initiative focusing on human resources development and a plan to cut corporation tax in Indonesia in order to become more competitive with regional countries.
Bank Indonesia surprisingly cut interest rate last August. Is there any potential for further BI interest rate cut again this year?
With the slowing down of global economic growth, we think BI will stay on its accommodative posture with further potential of interest rate cut. In our opinion BI still has room to cut interest rate, supported by a few factors:
- With 5.5% reference interest rate and 3.5% inflation, Indonesia real interest rate is still high enough at2%. This condition makes Indonesia as one of the countries with the highest real interest rate in the region, which means there is still room for interest rate cut.
- Domestic inflation is expected to be stable supported by global disinflation and the relatively reducing commodity prices.
- Stable Rupiah exchange rate, especially after second quarter which was the period with high USD demand.
With this condition, we predict there will be at least one BI interest rate cut towards the end of this year.
Speaking of Rupiah, Rupiah exchange rate to USD weakened to 15,000 last year as the trade war heated up. With no improvement in trade tension as of yet, do you see a risk of Rupiah weakening like last year?
Based on sentiments, this year’s condition does resemble last year’s, where the uncertainty of trade war continues to overshadow the market. But on the other side there is a different fundamental factor, which is the direction of The Fed interest rate. Last year The Fed aggressively increased interest rate 4 times which results in strong USD trend. Consequently, currencies in emerging countries region were under pressure, including Indonesia. This year The Fed shifted its stance to be more accommodative by cutting interest rate, which is a positive sentiment for Rupiah. Besides, in our opinion Rupiah exchange rate is also supported by attractive Indonesia assets, where there is a trend of decreasing interest rate and S&P sovereign rating upgrade.
What is your view on potential and risk of Indonesia equity and bond market with current condition? What ideal investment strategy should be applied by investors in current market condition?
Current domestic and global macroeconomic trend such as interest rate decrease, low inflation, and the number of bonds that have entered negative yield zone, become a direct catalyst for Indonesia bond market. We predict Indonesian government’s 10-year bond yield level can go lower to 6.5 – 7.0% this year, and therefore from the current yield level there’s still upside potential for bond market.
Meanwhile equity market also offers interesting value. In the first half of this year, financial market and business world are affected by the uncertainty of presidential elections which hindered the economy. In the second half, with the elections ended and more conducive political condition, we expect Indonesia economy will move better which will be reflected in better issuers’ performance in the second half.
In the midst of fluctuating financial market, and market direction that can swiftly changes by a mere comment from US or China officials, it is very important for investors to stick to their predetermined investment goal and asset allocation. Continuously changing asset allocation in the middle of fluctuating market will increase the risk of wrong market timing and missed opportunity. Investment diversification and disciplined asset allocation are the keys to achieve optimum investment return in the long run.
Seeking α is a monthly communication released by PT Manulife Aset Manajemen Indonesia (MAMI). Delivered in a Question and Answer format, Seeking α is intended to present the views of MAMI investment experts who are forward-looking, directly in front of you, MAMI professional investors.
This month we present the latest market comments from Chief Economist & Investment Strategist, Katarina Setiawan.
Chief Economist & Investment Strategist
Katarina joined PT Manulife Aset Manajemen Indonesia (MAMI) on July 1st 2013. Katarina has acquired Deputy Investment Manager from Bapepam-LK (Capital Market and Financial Institution Supervisory Agency) on April 30th 1999 number KEP-28/PM/IP/WMI/1999. She has more than 20 years of experience in the financial industry and stock market. Before joining MAMI, Katarina worked at Kim Eng Securities as Research Director. Previous to that Katarina worked as Director at IBAS Consulting, Director at Omni Nusantara, and Supervisor Consultant at Arthur Anderson & Co. Katarina holds Master of Business Administration degree from Indiana University, Bloomington, USA.
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