1
In last week’s FOMC meeting, the Fed announced that it had raised the Fed Funds Rate by 50 bps to a range of 0.75% - 1%. It will also begin reducing its USD 9 Tn balance sheet by letting USD 30 Bn of Treasuries and USD 17.5 Bn of mortgage-backed securities (MBS) roll-off for each of the three months starting in June – then increasing that to 60 USD Bn and USD 35 Bn for each in September.
Despite the tightening policy, the markets’ reaction to the meeting appeared positive, at least at first – as some market participants had anticipated an even more aggressive, 75 bps rate hikes.
Chair Powell also took the option of future 75 bps hikes off the table, signaling its unwillingness to deliver “shock-and-awe tactics” to bring inflation down. But the market’s reaction in the days after the meeting was quite chaotic – with equities declining and bonds recovering, but inflation expectations cratering at the same time. Taken together, this seems to show that the market is skeptical about the Fed’s ability to orchestrate a “soft landing”, and that an inflation-sapping recession may be at hand.
The reaction notwithstanding, we can clearly see how the Fed is able to justify its action through the lens of its dual mandate. Inflation – although at a historically high rate of 8.5% YoY – shows little signs of abating, especially with the impact of sanctions, China’s lockdown, and the looming food/fertilizer crisis. On the other hand, the US job market remains tight, while the latest GDPNow number (the GDP “nowcasting” model developed by the Atlanta Fed) shows that the US economy is still humming along at about 2% YoY (Chart 1). The contraction in Q1, it seems, was a mere fluke caused by swings in inventories and net exports.
Executive Summary
The Fed announced that it had raised the Fed Funds Rate by 50 bps to a range of 0.75% - 1%. Additionally, it outlined a program in which it will reduce its balance sheet in two stages: at a rate of USD 47.5 Bn per month in the June-August period and USD 95 Bn per month starting from September.
Even though the Fed’s hawkish turn over the past few months may make sense for the real economy, aggressive tightening may place too much stress on the financial sector and force the Fed to end its tightening cycle earlier than planned.
As the effects of the upcoming volatility may be quite substantial, some measure of adjustment in the form of larger (or slightly faster) rate hikes by BI will likely be needed.
FOMC:
Inflation vs financial market
11 May 2022
Keely Julia Hasim Economist/Analyst
Barra Kukuh Mamia Senior Economist
2
Unfortunately, what’s fit for the goose (real economy) might not be good for the gander (financial sector). The market is already showing signs of stress that may wreak havoc on the Fed’s plans.
This, ultimately, leads us to believe that there might be an extended period of volatility in the coming months, which would only end when the Fed abruptly stops its hawkish policy and returns to a ZIRP/QE combo to rescue the global market.
Let’s start with the first sign that’s easily apparent at the surface. The decline in equities and other risk assets is particularly worrisome since US households’ exposure to equities have risen to dot-com bubble levels during the pandemic, which implies a significant
negative wealth effect on consumers. In addition, the Fed’s plans to hike rates and shrink its MBS portfolio have also driven mortgage rates higher, making it harder for borrowers with floating rate mortgages. Both these effects may be to some extent intentionally engineered by the Fed to cool down the US economy, but the last time such policy was tried, it ended in the dot-com crash and subsequent recession, which took about three quarters to play out.
The second sign lies a little deeper in the money market. An orderly quantitative tightening (QT) would involve draining liquidity (at first) from the Fed’s overnight reverse repo (ON RRP) facilities, before affecting bank reserves which are more crucial to the functioning of the global financial system. However, before QT has even begun in earnest, bank reserves have started to decline quite sharply (Chart 2) – perhaps due to funding demands from peripheral or commodity markets.
This could be a warning that QT might not proceed as orderly as planned, despite the apparent cushion of excess cash that financial institutions are currently sitting on. Here we need to recall the Fed’s last attempt at QT back in 2018-19, where it only managed to reduce its balance sheet by around 15% before it had to reverse course as declining liquidity buffers pushed up short term lending rates.
Finally, the third and brightest warning sign comes from the peripheries, i.e. markets outside of the US, where rising UST yields have led to capital outflows and currency depreciation relative to the dollar, in addition to widening credit spread for sovereign bonds issued by “riskier” countries (Chart 3). This has led to increased policy uncertainty for the ECB, which faces a tough choice between a weaker Euro and rising bond yields in Southern European countries. Emerging markets, meanwhile, faces a situation not unlike the taper tantrum of 2013, albeit softened in some cases (including Indonesia’s) with the help of rising commodity prices.
So where do all this leave Indonesia? As we can see in (Chart 3), we have seen a significant increase in bond yields in recent days, but the Rupiah has been affected to a lesser degree. This points to several strengths that we have pointed in the past, namely the reduced exposure to foreign ownership in sovereign bonds and the commodity trade surplus that offset the capital outflow.
But as mentioned, the effects of the upcoming volatility might be quite substantial, perhaps more comparable to the dot-com crash or taper tantrum, rather than the more manageable challenges seen during the Euro crisis or the trade war. Meanwhile, the Fed’s focus on inflation and the US’real economy means that its reaction to halt the market turbulence might be quite delayed, in contrast to the swift (just 2-3 weeks) reaction that we saw at the beginning of the pandemic. As such, some measure of adjustment in the form of larger (or slightly faster) rate hikes by BI will likely be needed to help it manage the exchange-rate risk that could exacerbate inflation.
“What’s fit for the goose (real economy) might not be good for the gander (financial sector). The market is already showing signs of stress that may wreak
havoc on the Fed’s plans.”
3
Chart 1. The US economy remains strangely resilient, surprise Q1 contraction notwithstanding
Source: Federal Reserve Bank of Atlanta, Bureau of Economic Analysis
Chart 2. Bank reserves have started to decline, even before the start of the Fed’s QT program
Source: St. Louis Fed (FRED)
-1.4
0.37 1.85
-40 -30 -20 -10 0 10 20 30 40
50
Actual US GDP Growth (%)GDPNow (%)
Overnight Reverse Repurchase Agreements (LHS)
1.86
Bank Reserves (RHS)
3.30
1 3 5
0 1 1 2 2 3
Bank Reserves (USD Tn)
ON RRP (USD Tn)
4
Chart 3. .. and currency depreciation in peripheral countries, although Indonesia is faring better
Source: Bloomberg
Indonesi a
4.39 Malaysia
1.33 0
2 4 6 8
India
4.43
Thailand
0.32
-1 1 3 5 7
Germany
-1.94 Italy
0.11
Japan
-2.89 -3
-1 1 3
0.23 0.07
0.05 0.06 0.07 0.08
0.22 0.23 0.24 0.25
0.26 MYRUSD (LHS)
IDRUSD (RHS)
0.03 0.01
0.012 0.013 0.014 0.015
0.028 0.03 0.032 0.034
THBUSD (LHS) INRUSD (RHS)
1.05 0.01 0.007 0.008 0.009 0.01
1 1.1 1.2
1.3 EURUSD (LHS)
JPYUSD (RHS)
Difference in Yield
From UST 10Y Exchange Rate
5
Selected Macroeconomic IndicatorSource: Bloomberg, BI, BPS Notes:
^Data for January 2022
*Data from earlier period
**For changes in currency: Black indicates appreciation against USD, Red otherwise
***For PMI, >50 indicates economic expansion, <50 otherwise Key Policy Rates Rate (%) Last
Change
Real Rate (%)
Trade &
Commodities 10-May -1 mth Chg (%)
US 0.50 Mar-22 -8.00 Baltic Dry Index 2,939.0 2,055.0 43.0
UK 0.75 Mar-22 -6.25 S&P GSCI Index 723.2 720.4 0.4
EU 0.00 Mar-16 -7.50 Oil (Brent, $/brl) 102.5 102.8 -0.3
Japan -0.10 Jan-16 -1.30 Coal ($/MT) 348.8 292.9 19.1
China (lending) 4.35 Oct-15 2.25 Gas ($/MMBtu) 7.00 6.30 11.1
Korea 1.50 Apr-22 -3.30 Gold ($/oz.) 1,838.3 1,947.5 -5.6
India 4.40 May-22 -2.55 Copper ($/MT) 9,235.8 10,304.8 -10.4
Indonesia 3.50 Feb-21 0.03 Nickel ($/MT) 28,309.0 33,867.0 -16.4
CPO ($/MT) 1,601.4 1,544.2 3.7
Rubber ($/kg) 1.56 1.72 -9.3
SPN (1M) 3.07 1.83 123.7
SUN (10Y) 7.39 6.79 59.6
INDONIA (O/N, Rp) 2.79 2.79 -0.2 Export ($ bn) 26.50 20.47 29.4
JIBOR 1M (Rp) 3.54 3.55 -0.6 Import ($ bn) 21.97 16.64 32.0
Trade bal. ($ bn) 4.53 3.83 18.1
Lending (WC) 8.66 8.63 2.97
Deposit 1M 2.88 2.92 -3.51
Savings 0.69 0.69 0.87
Currency/USD 10-May -1 mth Chg (%) Consumer confidence
index (CCI) 113.1 111.0 113.1
UK Pound 0.812 0.768 -5.44
Euro 0.950 0.919 -3.20
Japanese Yen 130.5 124.3 -4.68
Chinese RMB 6.735 6.365 -5.49
Indonesia Rupiah 14,557 14,362 -1.34 Capital Mkt 10-May -1 mth Chg (%)
JCI 6,819.8 7,210.8 -5.42
DJIA 32,160.7 34,721.1 -7.37
FTSE 7,243.2 7,669.6 -5.56 USA 55.4 57.1 -170
Nikkei 225 26,167.1 26,985.8 -3.03 Eurozone 55.5 56.5 -100
Hang Seng 19,633.7 21,872.0 -10.23 Japan 53.5 54.1 -60
China 46.0 48.1 -210
Korea 52.1 51.2 90
Stock 2,599.7 2,463.5 136.15 Indonesia 51.9 51.3 60
Govt. Bond 827.9 848.3 -20.43
Corp. Bond 18.5 19.4 -0.92
N/A -13.6 -2.6
Mar Feb Chg
(%)
Mar Feb
Apr
139.1 141.4 -1.65
N/A 16.0 65.1
Foreign portfolio
ownership (Rp Tn) Apr Mar Chg (Rp Tn)
External Sector
Prompt Indicators
Car sales (%YoY)
Manufacturing PMI Cement sales (%YoY) Motorcycle sales (%YoY)
Central bank reserves ($ bn)*
Money Mkt Rates 10-May -1 mth Chg (bps)
Bank Rates (Rp) Jan Dec Chg (bps)
N/A 23.2 13.6
Chg (bps) Mar
Apr
6
Indonesia – Economic Indicators Projection** Estimation of Rupiah’s fundamental exchange rate
Economic, Banking & Industry Research Team David E.Sumual
Chief Economist
[email protected] +6221 2358 8000 Ext:1051352
Agus Salim Hardjodinoto Senior Industry Analyst [email protected]
+6221 2358 8000 Ext: 1005314
Barra Kukuh Mamia Senior Economist [email protected] +6221 2358 8000 Ext: 1053819 Victor George Petrus Matindas
Senior Economist
[email protected] +6221 2358 8000 Ext: 1058408
Gabriella Yolivia Industry Analyst
[email protected] +6221 2358 8000 Ext: 1063933
Derrick Gozal Economist / Analyst [email protected] +6221 2358 8000 Ext: 1066122 Livia Angelica Thamsir
Economist / Analyst [email protected] +6221 2358 8000 Ext: 1069933
Lazuardin Thariq Hamzah Economist / Analyst
[email protected] +6221 2358 8000 Ext: -
Keely Julia Hasim Economist / Analyst [email protected] +6221 2358 8000 Ext: - Ahmad Aprilian Rizki
Research Assistant [email protected] +6221 2358 8000 Ext: 20378
Arief Darmawan Research Assistant
[email protected] +6221 2358 8000 Ext: 20364
2017 2018 2019 2020 2021 2022E
Gross Domestic Product (% YoY) GDP per Capita (US$)
Consumer Price Index Inflation (% YoY) BI 7 day Repo Rate (%)
USD/IDR Exchange Rate (end of year)**
Trade Balance (US$ billion) Current Account Balance (% GDP)
5.1 3877
3.6 4.25 13,433
11.8 -1.6
5.2 3927
3.1 6.00 14,390
-8.5 -3.0
5.0 4175
2.7 5.00 13,866
-3.2 -2.7
-2.1 3912
1.7 3.75 14,050
21.7 -0.4
3.7 4350
1.9 3.50 14,262
35.3 0.3
4.8 4615
4.2 4.0 14,660
48.5 1.4
PT Bank Central Asia Tbk
Economic, Banking & Industry Research of BCA Group 20th Grand Indonesia, Menara BCA
Jl. M.H Thamrin No. 1, Jakarta 10310, Indonesia Ph : (62-21) 2358-8000 Fax : (62-21) 2358-8343
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