Macro Strategy
The Prelude to Rate Cut
- BI appears to add IDR liquidity, consistent with historical pre-rate cut cycle trends, by reducing SRBI auction and adding to its SBN holdings.
- Still a balance job data, with NFP below expectation but unemployment rate down to 4.2% while average hourly earnings rising faster to 3.8%.
- A gradual and predictable FFR cut is primary for market stability, as a larger rate cut would risk the return of recession fears.
Prelude to BI’s Rate Cut. The weakening DXY on FFR cut prospect has led to stronger IDR performance in recent weeks, with BI rate cut is also expected to follow. The sensible next move for BI would be to first scale back the level of contractionary measures before proceeding with any rate cuts. There are 4 points to note which points that BI has been relaxing its contractionary stance on IDR liquidity despite very minimal decline on overall OMO level:
- SRBI issuance starting in Sep-23 has become the main tools within BI’s contractionary policy, replacing RR SBN, whereby SRBI has longer maturities (6, 9, and 12 months) compared to the previous RR SBN, which had shorter terms (7, 14, 28 days, and 3 months). As such, while SRBI auction has gone down considerably, OMO outstanding only move down gradually (Exh. 1 and 2), unlike the previous easing cycle.
- BI’s increased activity in purchasing government bonds (SBN) in the secondary market is supporting liquidity in the system. Despite recent strong foreign inflows, BI continues to grow its SBN holdings. This move, in our opinion, helps inject IDR liquidity back into the system, particularly as banks have been the largest sellers of SBN.
- In Aug-24, BI's purchases of SBN exceeded SRBI issuances for the first time since Feb-24. Last week also marked the lowest SRBI issuance since May and extended BI's rising SBN purchases trend to 5-consecutive months.
- Through macroprudential incentives, BI has also provided liquidity support to the banking system. We note the near-full utilization of the Reserve Requirement (GWM) reduction incentive of c. 3.5%.
In conclusion, we believe that BI has been actively increasing IDR liquidity in the system, consistent with previous trends prior to a rate cut. The IDR has appreciated to below the 15.4k level, bolstered by a weaker DXY and a recent increase in FX reserves to USD150bn. We anticipate FX reserves will remain elevated, particularly following the successful issuance of INDOGB: 10-year USD1.15bn, 30-year USD650m, and 8-year EUR750m (settlement date 10 Sept), which would underpin stronger IDR and the start of BI’s rate cut cycle.
Still A-Mixed Bags. In the U.S., while nonfarm payrolls (NFP) data were below expectation, unemployment rate was down. The labor market has shown signs of slowing down since July 2024, with August NFP adding 142K jobs, falling short of the expected 160K and below the 12-month average of 200K. Additionally, July's NFP figure was revised down to 89K, marking the smallest job gains since 2021. While the service sectors remained strong, the manufacturing sector underperformed among goods-producing industries. This trend mirrors U.S. PMI data, with the service PMI staying in expansion territory while the manufacturing PMI has been in contraction for several months. The unemployment rate fell to 4.2%, as many workers temporarily laid off in July returned to their jobs. Average Hourly Earnings also increased at a faster rate, rising to 3.8% y-y (vs 3.6% in July), offering some balance to the overall labor market slowdown from a demand perspective. While the data appears still balance, UST yields dipped below the levels reached in early August 2024, when the unwinding of the Yen carry-trade and recession fears converged. At this level, the spread between the 2-year UST yield and the FFR widened significantly, reminiscent of previous crises, with the market now expecting larger FFR cuts at Nov and Dec FOMC meeting.
Gradual and Predictable Rate Cut is Key. The latest Federal Reserve Beige Book confirms that layoffs remain uncommon, with employment levels generally steady or slightly increasing across districts. Employee turnover has declined, easing wage pressures as companies face less competition for talent. However, businesses are becoming more cautious in their hiring practices due to ongoing economic uncertainty. On the inflation front, pressures are moderate, with rising freight and insurance costs while other commodity prices have stabilized. (Exh. 5) Expectations for price easing and a gradual slowdown in the job market support our forecast of a 25 bps rate cut at each of the remaining Federal Reserve meetings, bringing the Federal Funds Rate (FFR) to 4.75% by year-end. In our view, larger cut of 50bps would introduce recession fear, potentially triggering bear case for the overall market trajectory (please refer to our report: The Time Has Come), and would be ominous to emerging market trend.
This policy certainty and predictability in the U.S. could help mitigate cross-currency risks associated with the Bank of Japan (BoJ). The BoJ has signaled it may continue raising rates if domestic economic conditions justify further tightening. This is reflected in the recent growth in real wages for a second consecutive month and base pay increases at the fastest pace in nearly 32 years. The BoJ will closely monitor these indicators to inform future policy decisions. The risk of a Yen Carry Trade unwind seems to be diminishing, as CFTC data shows that speculative trades have been in a Yen net long position for the past four weeks (Exh. 6).
Capital Market – A Pause in Foreign Flows
Amid growing concerns about economic growth after weaker-than-expected job data, the 10-year U.S. Treasury (UST) yield declined by 15 bps to 3.72% last week, while the 2-year yield fell by 21 bps to 3.66%. This drop pushed UST yields below the levels reached in early August 2024, when the unwinding of the Yen carry-trade and recession fears converged. The 10-year Indonesian Government Bond yield edged down by 1 basis point to 6.62%.
On stronger FFR cut, the US Dollar Index decreased by 0.71% w-w, while the Indonesian Rupiah strengthened by 0.58% to IDR 15,365 per USD. Indonesia's 5-year Credit Default Swap (CDS) rose by 4 bps to 72 basis points.
Fixed Income Flows – MoF data as of 4th Sept showed weekly foreign outflow of IDR0.81tn, with an overall position down to IDR 850tn. Meanwhile, the banking sector saw an inflow of IDR19.46tn, a reversal from previous trend. Bank Indonesia recorded an outflow of IDR 15.74tn (excluding repo transactions), while mutual funds and insurance and pension funds posted inflows of IDR 1.16tn and IDR 1.70tn, respectively.
Equity Flows - In the first week of September 2024, foreign inflows totaled IDR 3.5 trillion, contributing to a 0.7% week-on-week rise in the JCI. Thanks to strong foreign inflows over the past 4 weeks (totalling IDR15.0tn), the year-to-date (YTD) figure turned positive, with a net inflow of IDR 2.4tn in the regular market.
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