Value in IDR govvies; better risk appetite in FX (except INR)
Indonesia government bonds were one of the hardest hit within Asia through the COVID-19 Pandemic crisis. Most of this has to do with the high levels of foreign ownership (close to 40% of outstanding) leading into a volatile March. That share is presently down to 32% of Indo govvies, suggesting that caution still lingers. The Indo govvie curve is steep, with the 2Y/10Y spread hovering around 150bps, high by historical standards. Part of this can be attributed to larger issuances to accommodate temporary increase in budget deficit to 6.3% of GDP (breaching the long-standing deficit ceiling of 3%) for 2020 as the government acted to cushion the fallout from COVID-19.
Bank Indonesia (BI) is now playing an active role in buying government bonds and has also encouraged banks to take on more government bonds. For local investors, we like extending duration out to the intermediate tenors, noting that BI will likely embark on another cut today and keep rates low for an extended period. That said, domestic demand for govvies will probably not be enough to nudge yields significantly lower. It would likely require a return of foreign investor interest (likely over the medium term) to nudge 10Y yields towards 7%. On that front, we are more optimistic over the medium term. Indo govvies screen well on our Asia Rates Valuation Indicator (ARVI)* and we suspect that investors will have improved appetite for EM debt when the global economic recovery gains traction.
*The ARVI is a standardized way to compare relative valuation between a 10Y local currency govvie vs 10Y US Treasuries. This takes into account macro factors including real rates and external funding dynamics (see here).
FX: Better risk appetite (except for INR)
EURUSD steadied but 1.10 remains a hurdle. EURUSD has risen above 1.09 again after languishing around 1.08 the past fortnight. There are three positives from the EUR500bn EU recovery fund proposed by Germany and France to fight the coronavirus on Monday. First, the proposal is one step closer to Eurobonds and would help mend some of the damage to EU unity from the German Constitutional Court’s ruling against ECB’s asset purchases last week. Second, the fund is targeted at helping EU nations hit hard by the coronavirus. Italian debt worries subsided; 10Y BTPS yield fell to 1.67%, its lowest level since 9 April. Third, this should temper the overly bearish growth expectations in the private sector. The Bundesbank’s weekly activity index has signalled 1Q’s weakness extending into April but improving in May. Hence, EUR’s fate today hinges on a better ZEW survey for May.
NZDUSD recovers into 0.60-0.62 range on improved risk appetite. Commodity-led currencies benefitted most on Monday from higher oil prices and global equities. WTI crude oil prices closed above USD30/bbl, four weeks after it went negative for a day. Global equities rallied after Moderna Inc, a US biotech firm, reported that its initial vaccine trials have been positive in building immunity against the coronavirus. For many governments, a vaccine is key to reopening economies fully. Regulatory approval is, however, expected only by end-2020 after its third trial (that starts in July) across large populations. Fed Chairman Powell is expected to tell the US Senate Banking Committee tonight that a full recovery next year requires not only a vaccine but also the additional fiscal support. On the latter, the Treasury is banking on low rates to borrow almost USD3trn in 2Q.
INR is under pressure within its 75-77 range. Sensex has lately fallen to near 30,000 (post-pandemic peak was 34,000 at the end of April). The Indian economy remains under pressure from the lockdown extension to 31 May, with the number of coronavirus cases surpassing 90k. Also, questions remain about the reach and efficacy of the government’s support packages announced so far, along with the trade-off between growth over fiscal slippage. The rebound in oil prices (WTI closed above USD30/bbl on Monday) is marginally negative for the world’s third largest oil importer. Weaker domestic demand has not only narrowed the trade deficit but also lowered CPI inflation to 5.8% yoy in March from its 7.6% peak two months earlier. Bond yields have eased in anticipation of more monetary support at the next central bank meeting on 5 June.
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