Indonesia bond bulls bet on rate cuts as hike-cycle end signalled

TRADERS anticipating the rally in Indonesian bonds will extend through the year face a pivotal test when Bank Indonesia (BI) meets next week.

Indonesian benchmark yields tumbled to the lowest in over a year this month as inflation slowed more than expected and BI governor Perry Warjiyo signalled the rate-hiking cycle has ended. Citigroup and Societe Generale said the central bank will begin cutting interest rates later this year, possibly by as much as 75 basis points.

If Warjiyo reinforces his dovish stance at next week’s meeting, that may add a fillip to the rally in Indonesian debt that has offered dollar-based investors a total return of 10 per cent this year, the best in emerging Asia.

Investors will also be watching for any commentary on BI’s so-called Operation Twist that was pared back in January to just selling short-term notes.

“In addition to indications on rate cuts, announcements regarding Operation Twist could be pivotal for these bets,” said Vijay-Vikram Kannan, Asia macro strategist at SocGen in Singapore.

“Given the benign outlook on domestic inflation and relatively resilient rupiah, Indonesian government bonds remain one of the more attractive local currency yields, in my opinion.”

The rupiah’s almost 5 per cent gain against the greenback in 2023 means that BI could cut rates without worrying about excessively weakening the currency.

Traders are betting that the central bank will be among the first in emerging Asia to cut rates after a rapid 225-basis-point hike campaign from August to January to tame consumer cost rises and support the local currency.

Since then, BI has turned its focus to maintaining growth as inflation cools to within its 2 per cent to 4 per cent target band and the rupiah has strengthened the most among major Asian currencies so far this year.

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BI’s move and bets the global rate hike cycle is also ending have seen foreign investors plough US$4.1 billion into Indonesian debt this year, the second biggest inflow in Asia, according to data compiled by Bloomberg.

JPMorgan Asset Management expects to increase its holdings and eventually surpass that of its allocation to China, bolstered by the stronger rupiah. Others see the bonds as a potential haven from the US debt-ceiling crisis.

Not everyone expects BI to cut rates this year. The central bank is likely to stay on hold for the remainder of 2023, according to a Bloomberg survey of economists. Warjiyo said recently the central bank will “be patient” on its next move.

In fact, analysts polled by Bloomberg expect Indonesia’s two-year and 10-year sovereign bond yields to rise to 5.98 per cent and 6.58 per cent respectively in the final quarter, up from 5.79 per cent and 6.36 per cent on Wednesday (May 17), moves that would be unusual if BI had eased.

“For now, we see little need for rate cuts this year given firm domestic prospects, and with BI likely to remain vigilant against possibly sticky food prices if or when El Nino returns,” Mohamed Faiz Nagutha and Kai Wei Ang, economists at Bank of America, wrote in a note to clients.

“We continue to expect 100 basis points of rate cuts next year as inflation eases further and the US Federal Reserve cuts rates.” BLOOMBERG