(Bloomberg) — Indonesia’s central bank defied the expectations of practically the entire market when it cut interest rates this week, deepening a period of uncertainty for government bond yields.
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Bank Indonesia cut its policy rate by 25 basis points to 5.75% on Wednesday, despite all 38 economists surveyed by Bloomberg saying they expected the central bank to stand pat.
“It was a risky move by Bank Indonesia which increases financial risk for the country,” said Rajeev De Mello, a global macro portfolio manager at Gama Asset Management SA. “With the imminent policy uncertainty emanating from the US, it is really not the time for EM central bankers to ease monetary policy.”
The move came after a prolonged selloff in the country’s government bonds, with the 10-year yield rising by more than 50 basis points since the US election on Nov. 6 — the largest such jump in emerging Asia.
The rate cut is likely to ease the pressure on yields in the near-term, but it has also forced investors to once again reassess their expectations for a central bank that has a history of throwing curveballs.
Bank Indonesia has recently appeared more focused on defending the rupiah against a strong dollar, and the country’s beleaguered currency — which has lost 4.5% against the greenback over the past 12 months — was one of the key reasons many investors expected the central bank to delay rate cuts. That assumption has now been proved false.
“We have changed our stance, which is to pro-stability and growth,” Bank Indonesia Governor Perry Warjiyo said at a briefing in Jakarta on Wednesday. He said the central bank continues to look for room for “interest rate cuts in line with global and national economic dynamics.”
Indonesia’s 10-year bond yield rose to 7.32% before the decision, hitting its highest level since Nov. 2022. It moved lower after the cut, closing at around 7.27%.
But the outlook for yields is increasingly muddled. One key question for investors is whether the impact of the rate cut on the currency will exacerbate pressure on bond yields. The 90-day correlation between the rupiah and the yield of a Bloomberg Indonesia local-currency bond index stands at -0.58, signaling that the two have been moving in opposing directions. It is the most inverse correlation between yields and currency performance in emerging Asia.
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The rupiah closed at 16,320 per dollar on Wednesday, its weakest level since July.
Despite the rate cut, the 10-year yield could still rise towards 7.75%-8%, especially if US-China trade tensions escalate, said De Mello.
Front-Loading Issuance
There are signs that bond supply in the country will outstrip demand in the coming months. Indonesia’s conventional bills and bond auction on Jan. 7 received cumulative bids of 32 trillion rupiah ($2 billion), with 26 trillion of bonds sold — a bid-to-cover ratio of 1.21 times. That was the lowest bid-to-cover in at least five years, according to data compiled by the country’s Debt Management Office (DMO).
“The DMO appears keen to front-load as much issuance as possible in the first quarter, to build up buffers against risks of challenging funding conditions and also an early Ramadan starting in late February,” said Winson Phoon, head of fixed-income research at Maybank Securities Pte in Singapore.
Bank Indonesia is planning to buy around 150 trillion rupiah of bonds in the secondary market this year, Governor Warjiyo said in December. That’s more than the central bank’s roughly 100 trillion rupiah of pandemic-era bond holdings that are set to mature in 2025.
Global funds pulled out $152 million from Indonesia’s bond market on Monday, the largest single-day outflow in two months, according to data from the Ministry of Finance. The outflow followed a strong US employment report on Friday, which fueled bets that the Federal Reserve may slow the pace of its own rate cuts.
–With assistance from Matthew Burgess.
(Updates with Bank Indonesia’s bond buying plan in the penultimate paragraph)
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