Interest rate spread advantage + policy space, Indonesian bonds may become the biggest winner of the Federal Reserve's interest rate cuts

According to the Zhitong Finance APP, as expectations for interest rate cuts by the Federal Reserve continue to rise, the Asian bond market is generally bullish, with Indonesian bonds expected to be the biggest winners. As one of the highest-yielding sovereign bonds in Asia, the yield on Indonesian benchmark government bonds is close to 6.5%, which will make Indonesian rupiah bonds particularly outstanding. Notably, the Bank of Indonesia is one of the few central banks that has stabilized the exchange rate as a core policy objective, meaning it can further ease monetary policy by taking advantage of a weaker dollar without worrying about depreciation pressure on its currency. Rajeev De Mello, portfolio manager at Geneva-based GAMA Asset Management, stated: "In the context of a weaker dollar, the Asian local currency bond market, especially the Indonesian market, will benefit significantly. Currently, Indonesian bonds occupy an important proportion in our emerging market local currency bond allocation." As the correlation between the dollar and the Indonesian rupiah exchange rate and the local 10-year government bond yield continues to strengthen (the 30-day correlation has reached its highest level since July 2024), a weaker dollar will boost the appreciation of the Indonesian rupiah and further lower bond yields. On Monday, the yield on Indonesia's 10-year government bonds fell by 9 basis points, marking the largest decline in emerging Asia. This trend followed last Friday's drop in U.S. Treasury yields for the same period, when weaker-than-expected non-farm payroll data significantly increased the likelihood of a rate cut by the Federal Reserve next month. Due to the narrowing interest rate spread, Indonesian rupiah bonds have become increasingly sensitive to fluctuations in U.S. Treasury yields. Currently, the spread between Indonesian and U.S. 10-year Treasury yields is about 220 basis points, which is 1.1 standard deviations below the five-year average. Goldman Sachs strategists Danny Suwanapruti and Xinquan Chen wrote in a report on Monday: "Indonesian rupiah bonds do have room for appreciation, but they need U.S. Treasury yields to first open an upward channel." Although concerns about the widening fiscal deficit continue to constrain the performance of Indonesian bonds, expectations for interest rate cuts by the central bank are likely to alleviate some of these pressures. Additionally, after the Indonesian rupiah recorded its largest decline since February in July, it rebounded in August, clearing the way for the central bank to cut rates. Bank of Indonesia Governor Perry Warjiyo reiterated last week that after cumulative rate cuts of 75 basis points this year, there is still room for further rate cuts. GAMA's De Mello stated that the Federal Reserve's restart of the easing cycle will provide the Bank of Indonesia with policy follow-up space. "We expect the Bank of Indonesia to implement at least two more 25 basis point rate cuts by the end of the year."