IDR Rates: “Burden-sharing” a positive for IndoGB

Via capping upside to yields and hence duration risks, BI's announcement is likely to encourage locals and foreigners to extend on duration and lead to curve-flattening.
Duncan Tan, Eugene Leow02 Sep 2021
  • Return of "burden-sharing" is a game-changer – Local factors will outweigh external risks
  • Reduction in net IndoGB issuance will be quite material, especially over the next 4 months
  • Yield sensitivities to external risks are likely to stay low for much longer
  • 10Y IndoGB yields will grind lower from here, and break below 6% before year-end
  • Implications for investors: Duration is cheap. Initiate long 10Y IndoGB idea at 6.085%, target 5.8%
Photo credit: AFP Photo

Bank Indonesia (BI)'s announcement of a return to "burden-sharing" arrangements through end-2022 represents a game-changer for our outlook on Indonesia government bonds (IndoGB). Prior to the announcement, we thought that external risks (upcoming Fed taper, our forecast for higher US rates and stronger USD) would point to higher IndoGB yields, while local factors (flush onshore liquidity, steep curve) would argue for lower yields. And in determining our IndoGB yield forecast, we had assigned a larger weight to the external risks component, and therefore, had projected IndoGB yields to rise through end-1Q22. However, a return to "burden-sharing" has now upended our prior thinking. We now expect external risks to lose some significance and local factors to ultimately outweigh from here - Such a reweighting suggest that IndoGB yields would flip to a downside bias.

Beyond a significant reduction in net IndoGB supply (available to bond markets), well-anchored yield expectations underpinned by BI's commitment likely mean that IndoGB yields will be more stable/resilient to external risks. The positive market reaction to the second edition of "burden-sharing" is also pivotal, and forms the basis of our conviction that the boost to IndoGB returns outlook can be sustained. IDR and IndoGBs are both rallying and there has been ~IDR4tn (USD0.3bn) of foreign inflows into IndoGBs in recent days.

Material reduction in net issuances ahead

In the coming months, IndoGB buyers will likely find themselves chasing a much smaller supply and in the process, push yields and yield expectations lower. The degree of demand-supply mismatch is likely to be greatest over the remaining months of 2021. For Sep-Dec period, we are projecting net IDR issuances of ~IDR445tn, of which IDR215 (48%) will be absorbed by BI via private placements. If the issuance calendar is unchanged, conventional bond auction issuance sizes will sharply decline from IDR30-34tn earlier in the year to IDR22-24tn in Sep-Dec period. Alternatively, MOF could maintain auction issuance sizes at ~IDR30tn and cancel the last 1-2 auctions scheduled for the year. Regardless, the reduction in net IndoGB issuance (available to bond markets) will be quite material ahead.

Recent statistical relationships suggest that when BI is absorbing ~50% of net IndoGB issuances, 10Y IndoGB yields can narrow against 10Y US Treasury (UST) by as much as 60-80bps. Since BI's announcement, 10Y IndoGB yields have already outperformed by 30bps, implying possible scope for 30-50bps of further outperformance. Against our year-end 10Y UST yield forecast of 1.60%, 10Y IndoGB yields can fall to as low as 5.85% before year-end, based on the line of reasoning.

Strong anchor for yield expectations

Besides supply tailwinds, we expect BI's "burden-sharing" commitment to provide a strong anchor for IndoGB yield expectations. Yield sensitivities to external risks are likely to stay low (relative to pre-COVID norms) for much longer, suggesting that IndoGBs yields could be more resilient against upcoming Fed taper and possible EM volatility.

Foreigners’ ownership share of IndoGB will likely continue to be diluted by BI and local banks' higher pace of buying, and could fall below 20%, which will reinforce stability (from external gyrations) in yields. Even with the recent decline in IndoGB yields, we think the carry-to-volatility profile remain quite attractive.

Duration still cheap beyond the 5Y

In positioning for our revised IndoGB outlook, we favour duration, particularly 10Y and 20Y IndoGBs. For much of this year, the flush onshore liquidity has disproportionately benefitted local banks' bid for shorter-dated IndoGBs (3Y to 5Y), allowing those tenors to be better anchored. On the other hand, longer duration (10Y and 20Y) has cheapened, as seen in the wide spreads versus the 5Y.

Via capping upside to yields and hence duration risks, BI's announcement is likely to encourage locals and foreigners to extend on duration and lead to curve-flattening. In our view, 10Y IndoGB yields will grind lower from here, and will break below 6% before year-end. We initiate a long 10Y IndoGB idea at 6.085%, target 5.8%, stop-loss 6.4% with max holding period of 3-4 months.

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Duncan Tan

FX and Rates Strategist - Asean

Eugene Leow

Rates Strategist - G3 & Asia

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