Live Chat Software
Berita Dan Riset Terbaru
Weekly Update
Danareksa Debt Research Weekly Report, 11 Jul 2019 : Timing the Next Move
July 11, 2019 15:00

Timing the Next Move

Fluctuation of the trade war
The trade war between the US and China escalated during the second quarter. Due to sluggish trade negotiations, Trump made the decision to challenge China through his Twitter account on 6 May 2019. Then on 10 May 2019, the US Government officially increased tariffs on US$200 billion of imports of Chinese goods from 10% to 25%. 3 days later, the Chinese Government retaliated by raising the tariffs on the imports of US$ 60 billion of goods. At the G20 Summit held in late June in Japan, Trump and Xi Jinping finally met and the two leaders agreed that negotiations between the two sides should continue.

The trade tensions have led to greater global economic uncertainty, such that demand for safe-haven instruments (US treasuries) has increased. This is evident from the significant downward trend in US treasury yields. As of the end of June 2019, the 10-year US treasury yield was 2.00%, or down 69bps compared to its level at the end of last year. In addition, the difference between the 10-year US treasury and the Fed Rate dropped from 19bps to negative 50bps. Based on historical data, a negative spread between the two interest rates is an early indicator of an incoming recession.

More dovish tone from the Fed
In the second quarter of 2019, the Federal Reserve (Fed) held 2 FOMC meetings on 30 April and 18 June. Although the Fed chose to keep interest rates in the range of 2.25% - 2.50%, it also signalled that cuts in interest rates in the future were more likely. At the press release of the FOMC meeting on 30 April, the Fed pointed toward continued expansion of the economy, a strong labour market and benign inflation which is in-line with the target of 2%. At the FOMC meeting on 18 June, however, the Fed said that the outlook was more uncertain, such that the “patient” tone highlighted at the FOMC meeting on 30 April was missing. In turn, this raised market expectations that the Fed would cut interest rates at the FOMC meeting at the end of July as reflected in the Bloomberg calculation for the Fed Rate implied probability (ticker: WIRP) as of 1 July 2019, showing that the chance of a cut in the Fed rate in July was 100%.

Of particular interest is the direction of Fed policy as reflected in the historical Fed Funds Rate (FFR) data for the past 18 years. The data shows that the Fed has never made adjustments to FFR interest rates (either raising or reducing them) in July in the past 18 years. Rather, the Fed made more adjustments to interest rates in December (50.00%), June (36.84%), March (31.58%), and September (27.78%)

When will Bank Indonesia cut its reference rate?
Some central banks have adopted loose monetary policies related to expectations of a global economic slowdown and more dovish Fed policymaking. On 7 May 2019, Bank Negara Malaysia lowered its benchmark interest rate for the first time in the past 3 years by 25bps to 3%. Meanwhile, in early June, the Reserve Bank of Australia (RBA) also cut interest rates by 25bps to 1.25%, its lowest-ever level. Meanwhile, the Reserve Bank of India (RBI) lowered its benchmark interest rate for the third time this year from 6% to 5.75% and changed its monetary policy stance from “neutral” to “accommodative”.

Unlike these countries, however, Bank Indonesia (BI), which held a Board of Governors’ Meeting (RDG) on 19-20 June 2019, decided to keep its BI7DRR benchmark rate at 6%. However, BI has signalled that it is considering reducing policy interest rates due to the low inflation rate and in a bid to maintain Indonesia’s economic growth. Meanwhile, to increase the availability of banking liquidity, BI reduced the Rupiah Statutory Reserves (GWM) for Conventional Commercial Banks and Islamic Commercial Banks / Sharia Business Units by 50bps to 6% and 4.5% respectively.

Widening current account deficit
Indonesia’s Balance of Payments (NPI) recorded a surplus of $2.4 billion during the first quarter of 2019, better than in the same period in 2018 when the deficit was $3.8 billion. Nevertheless, the Current Account Deficit (CAD) has grown in 2019 compared to 2018. During the first quarter of 2019, the CAD was recorded at $6.96 billion, or around 2.6% of the Gross Domestic Product (GDP). This figure is higher than the deficit in the first quarter of 2018 of $5.19 billion (2.01% of GDP). In other words, the improvement in the balance of payments during the first quarter of 2019 reflects an increase in the financial account surplus from $2.2 billion during 1Q18 to $10 billion in 1Q19.

In May 2019, the trade balance posted a surplus of $0.21 billion, or far better than in April when a deficit of $2.28 billion was recorded. This reflects an increase in exports of 12.4% from $13.1 billion to $14.7 billion. Imports, by comparison, dropped from $15.4 billion to $14.5 billion, down 5.6%. Thus, in 5M19, Indonesia’s trade balance recorded a deficit of $2.14 billion or an improvement from the $2.86 billion deficit recorded in the same period of 2018.

Meanwhile, during the second quarter of 2019, the Rupiah tended to appreciate against the US Dollar. Since the end of December 2018, the Rupiah strengthened 1.83% to IDR14,126 per US Dollar or up 0.82% compared to the end of the first quarter of 2019. On the other hand, the DXY index weakened 1.11% compared to the end of March 2019 to 96 points.

Bond Market Overview

Credit rating upgrade has created an opportunity
At the end of May 2019, international ratings agency Standard and Poor’s (S & P) increased Indonesia’s credit rating from BBB- (stable outlook) to BBB (stable outlook). The prospect of strong economic growth and prudent fiscal policy are the main reasons why S & P increased its rating to investment grade following Moody’s and Fitch. This move will reduce the required yield from investors and raise Indonesia’s attractiveness as an investment destination due to lower perceived risks. As such, Indonesia’s 5-year credit default swap (CDS), one of the indicators used to measure the level of risk, fell significantly during June. As of the end of June 2019, Indonesia’s 5-year CDS was recorded at 90bps, or down by 25bps from its position at the end of May 2019 of 115bps.

Could the Indonesia CDS be lower?
The potential for a decline in Indonesia’s CDS due to a higher rating from S & P can be predicted from the difference in the average CDS from the group of countries with a minimum rating of BBB- (without Italy) and BBB (without Indonesia). Based on Bloomberg data as of the end of June 2019, the CDS average for the BBB group was 55bps, or 31bps lower than the CDS average for the BBB- group (86bps). In addition, Indonesia’s position as the country that has the highest CDS in the BBB group signals greater potential for a reduction in its CDS. As of the end of June, Indonesia’s 5-year CDS was 92bps or 37bps higher than the CDS average for the BBB group.

Foreign investors: The end of the wait-and-see stance
The escalation of trade wars and the country’s general elections in April encouraged foreign investors to maintain their holdings in the Indonesian bond market. In the first quarter of 2019 foreign investors increased their holdings by IDR73.87 trillion to IDR967.12 trillion (38.26% of the total outstanding) at the end of March 2019. Then during April and May, foreign holdings declined by IDR17.56 trillion to IDR949.56 trillion as of May. However, in terms of the proportion to the total outstanding, foreign ownership only decreased by 0.37% from 38.26% to 37.88% in the same period.

In June 2019, foreign holdings in the Indonesian bond market increased significantly. This reflects the lower political uncertainty following the general elections in the country and the increase in Indonesia’s ranking by S&P. Foreign ownership grew by IDR39.19 trillion during June 2019 to IDR988.75 trillion, or 39.06% of the total outstanding. This is the highest proportion since April 2018. There was net buying by foreign investors of IDR95.50 trillion during the first semester of 2019, or more than in the same period in 2018 when foreign outflows reached IDR5.98 trillion.

Government bond issuances: well managed
Government bond issuances in the first semester reached IDR558.10 trillion, or 67.59% of the total requirement for 2019’s gross issuances of IDR825.7 trillion. This figure is higher than the target for the first semester (50%-60%). Of the total issuances, IDR118.93 trillion is of foreign currency bonds, or 21.31% of the total gross issuances. By comparison, the gross issuances of Rupiah-denominated bonds consisted of IDR297.41 trillion of conventional bonds (53.29%) and IDR141.76 trillion of Sukuk (25.40%). In addition, retail bonds and retail sukuk have also played an important role in the issuance of bonds in 2019. The issuance of Government retail instruments in 1H19 was recorded at IDR33.14 trillion, or 5.94% of the total gross issuances (the initial target for the full year is IDR60 - IDR80 trillion).

The target for the Government auction in the second quarter was achieved. With a target of IDR129 trillion, Government bond and sukuk issuances in the second quarter were recorded at IDR132.96 trillion. The total incoming bids during the second quarter were less than in the first quarter as were the accepted bids. This implies a lower bid-to-cover ratio for the second quarter. In the third quarter, there are 7 bond auctions and 6 sukuk auctions with an issuance target of IDR185 trillion.

Government bonds secondary market
The total volume per transaction for Indonesian bonds during the second quarter of 2019 was lower at IDR17.51 billion compared to IDR23.42 billion in 1Q19 and IDR19.69 billion in 2Q18. Meanwhile, the total transaction volume for 1H19 was IDR1,999 trillion, slightly lower than in the same period the previous year IDR2,155 trillion.

Corporate bond issuances
During the first semester of 2019, corporate bond issuances were slightly lower at IDR54.96 trillion compared to issuances in the same period of the previous year which reached Rp56.44 trillion. In 2Q19, corporate bond issuances reached IDR33.67 trillion, or higher than in 2Q18 when they reached IDR 27.43 trillion. The financial institution sector was still the largest issuer in 2Q19 (IDR13.17 trillion), followed by banking (IDR10.79 trillion). Based on the instrument rating, AAA rated instruments still dominated with a total value of IDR12.89 trillion.

Corporate bonds secondary market
The total volume per transaction of corporate bond during the second quarter of 2019 was higher than in the first quarter of 2019, but smaller than in the same quarter the previous year. In 2Q19, volume was recorded at IDR9.43 billion per transaction while the figures for 1Q19 and 2Q18 were IDR8.73 billion per transaction and IDR10.53 billion per transaction, respectively. The transaction volume in 1H19 reached IDR131.656 trillion with 14,500 transactions, or more than 13,188 transactions in 1H18 with total transaction volume of IDR120,518 trillion.

By issuer, ADMF bonds dominated the transaction volume in the second quarter of 2019, reaching IDR6.19 trillion, or accounting for 9.02% of the total transactions volume. In second and third positions were BEXI and SMFP with transactions volume of IDR5.68 trillion and IDR3.77 trillion, respectively.

More optimistic forecast
The escalation of the US-China trade war, slowdown in the global economy, and the shift in the direction of the Fed’s policies led to changes in several indicators that influenced the yields on Indonesian bonds. Interest rate cuts in several countries and room for the Fed to reduce interest rates have also had a significant effect. Projections for the 10-year US Treasury yield have fallen significantly compared to the previous quarter from 2.2-2.8% to 1.95-2.35%. With investors attracted toward safe-haven instruments, projected foreign ownership in Indonesian government bonds is estimated to stand at 38% -39%, or lower than the previous projection of 39% -40%. Meanwhile, several other factors such as room for Bank Indonesia to cut the benchmark interest rate and the increase in Indonesia’s S & P rating in May which impacted Indonesia’s 5-year CDS, then Danareksa’s projected Government Rupiah bonds yield (BTMM ID 10- year) is more optimistic (in the range of 7.13% -7.66%).