Indonesia’s Outperforming Bonds Are Near End of Winning Streak


Indonesia’s sovereign bonds have been the best performers in emerging Asia this quarter but their golden run looks set to end.

Negatives are starting to pile up, including a diminishing spread over U.S. Treasuries, rising fund outflows, concern about potentially higher hedging costs, and a willingness at Bank Indonesia to let yields rise.

Rupiah debt has returned 3.9% this quarter, according to Bloomberg Barclays indexes, the best performer among eight of the largest emerging-Asian nations. Gains have been driven by the highest yields in the region, muted local inflation and relative success in controlling Covid-19, especially versus its Southeast Asian peers. Thailand reported the highest one-day Covid deaths on Thursday.

Indonesia’s Outperforming Bonds Are Near End of Winning Streak

Still, some of the very factors that have led to the success of Indonesian bonds are now working against them.

The rally has driven down the extra yield that rupiah 10-year notes offer over U.S. Treasuries to about 480 basis points, from as much as 669 basis points a year ago. The spread is now about 0.5 standard deviations beneath the five-year average, putting it at the lower end of the historical range.

A second negative is fund outflows. Overseas investors cut holdings of rupiah debt by $4.68 billion last year, and have trimmed another $638 million in 2021, according to finance ministry data. This compares with inflows this year of $2.94 billion in Malaysia and $1.04 billion for Thailand.

There’s also the threat that the start of Federal Reserve tapering will lead to increased volatility in emerging Asian currencies -- and especially the high-beta rupiah -- leading to higher hedging costs.

Investors should pro-actively manage exposure to Asian currencies given their gyrations, and this is particularly critical for currencies such as the rupiah for which “hedging costs are typically high and volatile,” Irene Cheung, a senior strategist for Asia at Australia & New Zealand Banking Group Ltd. in Singapore, wrote in a note last week.

Indonesia’s Outperforming Bonds Are Near End of Winning Streak

Rupiah non-deliverable forwards -- a proxy for hedging costs -- have been relatively subdued in recent months, with the spread between one- and 12-month forwards hovering around 600 basis points, after being above 1,000 basis points in the second quarter of last year. Still, the contracts have the potential to move rapidly following any market shock, and typically drag rupiah bond yields higher too.

Lastly, Bank Indonesia has shown a willingness to let yields rise in order to prop up its fragile currency.

“As long as Indonesian yields do not overshoot compared to U.S. Treasury yields, a moderate level of higher Indonesian yields could be acceptable to Bank Indonesia,” said Kiyong Seong, an Asia rates strategist at Societe Generale in Hong Kong.

Indonesian bonds have generated a juicy return this quarter, but investors would be wrong to get complacent. All of the above factors suggest that the months ahead may be quite a bit rockier.

©2021 Bloomberg L.P.

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