Indonesian yield curve steepest since early 2023 on fiscal fears

[SINGAPORE] The gap between yields of Indonesia’s short- and long-dated bonds is poised to increase as concerns over the country’s fiscal outlook persist.

The spread between two- and 10-year bond yields climbed to about 114 basis points last week, the most since January 2023, although the gap has narrowed slightly in the past few days. Shorter-dated notes have rallied as Bank Indonesia (BI) lowered borrowing costs, while longer maturities remain vulnerable to the risk of budgetary shortfall, which may lead to more outflows.

“Near-term risk-reward favours the short end of the curve” on further prospective BI rate cuts, said Wee Khoon Chong, senior Asia-Pacific market strategist at BNY. “Investors may be reluctant to increase duration given the civil unrest and Cabinet reshuffle, while long-dated bonds are also at risk from the global sell-off in developed-market rates,” he added.

The gap between the two- and 10-year yields could widen to as much as 130 basis points, Wee said. The spread was at 109 basis points on Wednesday (Sep 10).

Violent protests and the abrupt removal of Sri Mulyani Indrawati as finance minister have triggered a sell-off in local debt amid growing doubts over fiscal discipline. While her successor, Purbaya Yudhi Sadewa, has pledged prudence, his promises to turbocharge the country’s economic growth have made investors wary.

Longer-dated rupiah bonds are also vulnerable to moves in US Treasuries due to the heavier concentration of global investors in those notes. That puts them at risk to pressure from sell-offs in developed-market peers such as the US, UK and Japan, amid worries over inflation and spending plans.

About 47 per cent of local government bonds held by foreigners are in mid- to long-dated notes, while bills and bonds of two years or less account for only 11 per cent of their holding.

The very long-end of emerging market local bond curves exhibit a “general drift higher alongside the shifts in core fixed income markets”, Goldman Sachs strategists, including Kamakshya Trivedi and Danny Suwanapruti, wrote in a note last week.

Indonesia’s curve steepening has also been driven by Bank Indonesia’s 125 basis points of cuts in this easing cycle so far, the largest in emerging Asia after Bangko Sentral ng Pilipinas. BI has signalled that further easing is on the cards.

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A bond auction on Tuesday, where the government failed to meet its indicative sales target for the first time since January, drew weak demand after Indrawati’s removal. BLOOMBERG