Fed hikes to test Indonesia’s resolve to maintain dovish stance

(Bloomberg) – Bank Indonesia says its monetary policy does not have to move in tandem with that of the Federal Reserve. Measures ranging from currency carry to bond spread buffers paint a different picture.

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Indonesia will face the greatest pressure to follow the Fed as U.S. policymakers step up to calm inflation in the coming months, according to Bloomberg’s analysis of six emerging Asian economies. This should further dampen demand for rupee-denominated sovereign debt, which suffered the largest outflow in more than a year last quarter.

Rupee stocks risk reversing the 4% gain they posted in 2021 as faster price pressures and global bond volatility cloud the outlook. The waning appetite for notes could complicate government efforts to finance a budget deficit that is already under pressure from soaring energy prices.

Bank Indonesia’s policy stance will be affected by the Fed’s pace of normalization, as “securing real yield spreads is imperative to maintain currency and rate stability,” said Kiyong Seong, Asian Rates Strategist at Societe Generale SA in Hong Kong. He now expects the central bank to raise rates in the second quarter from the previous third.

The spread between five-year rupee bond yields and US Treasuries of similar maturity narrowed to around 350 basis points this week, bolstering the case for Bank Indonesia to It is making its first rate hike since 2018. The spread is 1.6 standard deviations below the five-year average of 485 basis points.

The central bank will keep its benchmark rate at a record 3.5% until it sees clear signs of rising inflation, which should emerge around the third quarter, Governor Perry Warjiyo said in December. . Policymakers are expected to stick to a review on Thursday, according to the 29 economists in a Bloomberg survey.

Rupee stability

Another factor in favor of a rate hike is the need to preserve the stability of the rupee, which the central bank says is the most important factor for the local economy. The three-month implied carry of the Indonesian currency against the London interbank offered rate has averaged around 3% over the past four weeks, nearly one standard deviation below the five-year average, and is the lowest among its peers.

In this regard, it may be worth noting that Bank Indonesia is unlikely to rise absent a sharp decline in the Rupiah. The currency has lost 2% against the dollar over the past three months, with rising US yields adding to the greenback’s appeal.

Policy gap

History also suggests that Bank Indonesia will raise borrowing costs. The policy gap between Indonesia and the United States narrowed to 250 basis points in March 2018 after the Fed started to hike in 2016, while Bank Indonesia was in the middle of a cycle of relaxation. The Southeast Asian economy responded by raising benchmark rates by a total of 175 basis points in 2018.

Economists polled by Bloomberg expect Bank Indonesia to raise rates by 25 basis points this year. As fed funds futures price an increase of one percentage point, the policy gap will narrow to 250 basis points, nearly 2 standard deviations below the average since 2016. This represents the narrowest projected policy gap among emerging Asian economies.

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