PT Bank Central Asia Tbk 20th Grand Indonesia, BCA Tower Jl. M.H Thamrin No. 1 Jakarta, Indonesia Ph : (62-21) 2358-8000
FOMC: Between a rock and a hard place
Executive Summary:
The Fed announced that the Fed Funds Rate would remain unchanged at 0 to 0.25% after January’s FOMC meeting. Additionally, interest rate hikes were deemed to “soon be appropriate,” and that the reduction of the Fed’s balance sheet would follow not long after.
While the current economic pressures appear to be in favor of more aggressive monetary tightening, the Fed is constrained by its inability to move too quickly without setting off market panic.
Even with uncertainty with regard to the Fed’s tightening timeline however, we still expect BI to only hike rates by 50 bps – as the planned RRR hikes would buy it more time to be more accommodative in its policy rate.
The Fed announced that the Fed Funds Rate would remain unchanged at 0 to 0.25% after January’s FOMC meeting.
More eventful perhaps, were its announcements that interest rate hikes were deemed to “soon be appropriate,” and that the reduction of the Fed’s balance sheet would follow not long after.
Market reaction unfortunately, was less than ideal. Fed Funds Rate futures jumped substantially over the course of the FOMC meeting, with markets now expecting four to five rate hikes in 2022, higher than the three hikes projected in the Fed’s December dot plot (Chart 1). The VIX index also spiked over the past few days, indicating increased market turbulence. These adverse signs are likely to be symptoms of a market increasingly wracked by uncertainty over the Fed’s timeline for monetary tightening.
This is particularly true with regards to the Fed’s balance sheet, and the timeline for its reduction. Although the Fed seems more inclined to take a “softer” approach to the reduction of its balance sheet, with its intention to rely primarily on “rolling off” maturing securities rather than actively selling them off, multiple uncertainties remain.
Few specifics for instance, were provided regarding the exact details and timeline for the reduction of its balance sheet. The Fed’s own statements also allowed room for a course correction with regards to its balance sheet should such a need arise.
This need of course, persists in the form of inflation’s still uncertain outlook. While monetary tightening by the Fed can ease inflationary pressures form the demand-side, its capacity to curtail supply-side inflation is more limited. And so while supply disruptions are predicted to ease into H2-2022, several wildcards remain that could increase supply-side inflationary pressures in the short term. Tensions between Russia and Ukraine for instance, have caused analysts to predict that
oil prices could rise past USD 100 per barrel. Political disruptions in Ukraine, which houses most of the pipelines connecting Russia’s oil and gas fields to Europe, could very well worsen Europe’s already acute energy shortage.
Furthermore, Beijing’s continued adherence to its zero- Covid strategy means that Omicron’s high transmissibility could potentially cause severe outbreaks and lockdowns in China, further worsening supply-chain bottlenecks.
While all these factors appear to support the argument for aggressive monetary tightening however, the Fed remains constrained by the risks of overly fast tightening. A case in point is the Fed attempt’s to pare down its balance sheet back in 2019, where it only managed to reduce its balance sheet by around 15% before it had to reverse course as declining excess reserves sparked a sell-off in assets that pushed up short- term lending rates.
Additionally, the generous monetary largesse provided since the beginning of the pandemic has helped drive asset valuations to historic highs. There is a risk that an overly hasty withdrawal of monetary support may cause some of these valuations to collapse, with implications of broader market panic. This is particularly worrisome due to the fact that households’
exposure to equities have risen to dot-com bubble levels, meaning that market panic could have potentially significant effects on the real economy as well.
Fortunately, a slight buffer remains in the fact that financial institutions are currently sitting on a pile of excess cash, which gives the Fed some leeway to slash liquidity before triggering more serious financial shortages in most institutions (Chart 2).
The Fed’s overnight reverse repo facility is perhaps the closest proxy to this excess cash, which averaged around USD 1.6 trillion per night over the past month.
Economic, Banking & Industry Research of BCA Group
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The Fed then, is caught between conflicting forces. While current economic pressures appear to be in favor of more aggressive monetary tightening, the Fed is constrained by its inability to move too quickly without setting off market panic. It is these contradictory forces that makes it quite difficult to pencil in an exact schedule for the Fed’s monetary timeline.
Even with uncertainty with regard to the Fed’s tightening timeline however, for now, we still expect BI to only hike rates by 50 bps in 2022 – as
the planned RRR hikes would buy it more time to be more accommodative in its policy rate. While Indonesian short-term rates may not rise as much as the Fed’s, there is room for further increase in Indonesian long-term yields, especially as they have not moved as much amid recent movements in US treasury yields.
Chart 1. Fed Funds Rate futures jumped substantially over the course of the FOMC meeting, with markets now expecting four rate hikes in 2022.
1.21 1.74 1.96
0 0.25 0.5 0.75 1 1.25 1.5 1.75 2
Dec-2022 Dec-2023 Dec-2024
Source: Bloomberg (last update: 27 Jan 2022)
%
Fed Funds Rate futures:
3
Indonesia – Economic Indicators Projection
* Provisional numbers for 2021
** Estimation of Rupiah’s fundamental exchange rate
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
4.0*
4350*
1.9 3.50 14,262
35.3 0.6*
5.2 4640
3.3 4.0 14,660
30.6 0.1
Chart 2. Compared to 2019, financial institutions are currently sitting on a pile of excess cash, which gives the Fed some leeway to slash liquidity before triggering
more serious financial shortages in most institutions
Source: St. Louis Federal Reserve, Bloomberg
1613.05 8867.83
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000
Ja n -1 7 Ap r- 17 Jul -17 O ct- 1 7 Ja n -1 8 A p r- 18 Jul -18 O ct- 1 8 Ja n -1 9 A p r- 19 Jul -19 O ct- 1 9 Ja n -2 0 A p r- 20 Jul -20 O ct- 2 0 Ja n -2 1 A p r- 21 Jul -21 O ct- 2 1 Ja n -2 2
USD Bn
Overnight Reverse Repurchase Agreements (USD Bn) Fed Balance Sheet (Bn USD)
Between 2017 and 2019, the Fed managed to reduce its balance sheet by 15% before it had to reverse course
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Selected Recent Economic Indicators
Source: Bloomberg, BI, BPS Notes:
*Previous data
**For change in currency: Black indicates appreciation against USD, Red indicates depreciation
***For PMI, > 50 indicates economic expansion, < 50 indicates contraction Key Policy Rates Rate (%) Last
Change
Real Rate (%)
Trade &
Commodities 26-Jan -1 mth Chg (%)
US 0.25 Mar-20 -6.75 Baltic Dry Index 1,296.0 2,217.0 -41.5
UK 0.25 Dec-21 -5.15 S&P GSCI Index 619.5 558.3 11.0
EU 0.00 Mar-16 -5.00 Oil (Brent, $/brl) 90.0 76.1 18.2
Japan -0.10 Jan-16 -0.90 Coal ($/MT) 234.6 165.5 41.8
China (lending) 4.35 Oct-15 2.85 Gas ($/MMBtu) 4.45 3.55 25.4
Korea 1.25 Jan-22 -2.45 Gold ($/oz.) 1,819.6 1,810.3 0.5
India 4.00 May-20 -1.59 Copper ($/MT) 9,952.5 9,595.0 3.7
Indonesia 3.50 Feb-21 1.63 Nickel ($/MT) 23,047.0 20,138.0 14.4
CPO ($/MT) 1,313.0 1,202.9 9.2
Rubber ($/kg) 1.74 1.67 4.2
SPN (1M) 2.03 3.26 -122.7
SUN (10Y) 6.40 6.32 7.9
INDONIA (O/N, Rp) 2.79 2.79 -0.1 Export ($ bn) 22.38 22.84 -2.0
JIBOR 1M (Rp) 3.55 3.55 0.0 Import ($ bn) 21.36 19.33 10.5
Trade bal. ($ bn) 1.02 3.52 -71.0
Lending (WC) 8.78 8.85 -6.86
Deposit 1M 3.13 3.24 -10.58
Savings 0.72 0.73 -1.87
Currency/USD 26-Jan -1 mth Chg (%) Consumer confidence
index (CCI) 118.3 118.5 113.4
UK Pound 0.743 0.747 0.58
Euro 0.890 0.883 -0.70
Japanese Yen 114.6 114.4 -0.23
Chinese RMB 6.321 6.368 0.74
Indonesia Rupiah 14,353 14,197 -1.09 Capital Mkt 26-Jan -1 mth Chg (%)
JCI 6,600.8 6,562.9 0.58
DJIA 34,168.1 35,950.6 -4.96
FTSE 7,469.8 7,372.1 1.32 USA 58.8 60.6 -180
Nikkei 225 27,011.3 28,782.6 -6.15 Eurozone 58.0 58.4 -40
Hang Seng 24,289.9 23,223.8 4.59 Japan 54.3 54.5 -20
China 50.9 49.9 100
Korea 51.9 50.9 100
Stock 2,286.1 2,233.2 52.91 Indonesia 53.5 53.9 -40
Govt. Bond 891.3 918.5 -27.11
Corp. Bond 22.9 22.4 0.47
-0.9 -2.6 5.3
Chg (bps) Nov
Dec Money Mkt Rates 26-Jan -1 mth Chg
(bps)
Bank Rates (Rp) Oct Sep Chg
(bps)
Foreign portfolio
ownership (Rp Tn) Dec Nov Chg (Rp Tn)
External Sector
Prompt Indicators
Car sales (%YoY)
Manufacturing PMI Cement sales (%YoY) Motorcycle sales (%YoY)
Central bank reserves ($ bn)
67.4 95.6 39.9
Dec Nov Chg
(%)
Nov Oct
Dec
144.9 145.9 -0.66
68.1 62.4 54.1
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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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Agus Salim Hardjodinoto Barra Kukuh Mamia Victor George Petrus Matindas
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Keely Julia Hasim Lazuardin Thariq Hamzah Ahmad Aprilian Rizki
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