Wednesday, April 2, 2014

Why Indonesia's Bond Rally is Limited

While Indonesia's economic data continue to be supportive of the ongoing rally in the country's government bonds, we believe that yields are likely to end the year higher than they currently are. Notably, headline inflation registered 7.3% on-year in March,
sliding from 7.8% in the preceding month while the trade balance returned to a surplus of about US$800 million in February, from a deficit of about US$400 million in January. On the back of easing external funding concerns, the yield on ten-year Indonesian government bonds has fallen by 120 basis points to 7.9%, while the yield on two-year Indonesian government bond has fallen by 70 basis points to 7.3% since early January.
While further downside in yields is possible in the short-term, with no rate cuts expected this year, downside is likely capped. There is also a need to keep an eye on the trajectory of US Treasury yields in the coming quarters even if the spread between Indonesian government bond yields and Treasury yields has normalised. As Federal Reserve tapering progresses, Treasury yields are expected to increase over the medium-term with upward impetus becoming more obvious when inflation starts to grind higher. Accordingly, this development would also put renewed upward pressure of Indonesian government bond yields. By the end of the year, we expect two-year and ten-year bond yields to reach 7.6% and 8.5%, respectively.