US Dollar, Yen, VIX, Gold, Crude Oil Analysis: COT Report

Commodity

Forex

Summary:

Net-short exposure to yen futures rose to a 16-year high last week, and now within reach of its record. Asset managers appear to be on the right side of the US dollar trade, with large speculators remaining net-short despite the dollar's rally...

Market positioning from the COT report - as of Tuesday March 19, 2024:

Net-short exposure to yen futures rose to a 16-year high among large speculators.
Shorting the Swiss franc remained in favour, with large speculators increasing short exposure by +11% (+4.8k contracts) and reducing longs by -21.6% (-4.6k contracts).
Large speculators were net-short for a fourth week and by their most bearish amount in 18 weeks.
Whilst net-short exposure to AUD/USD futures fell for a third week by last Tuesday, I suspect many have returned since the latest batch of Middle East headlines.
Large speculators increased long gold exposure by 15.7% (+10.1k contracts) and reduced shorts by -7.1% (-8.4k contracts), whereas asset managers are on the cusp of flipping to net-long exposure for the first time in nearly five months.
Asset managers increased long exposure to VIX futures by 14.7% (+2.2k contracts).
Net-long exposure to Dow Jones futures fell to a YTD low among asset managers.

US Dollar, Yen, VIX, Gold, Crude Oil Analysis: COT Report_1

US dollar index positioning – COT report:

I noted the divergence between asset managers and large speculators regarding net exposure, and with the US dollar rising it seems that asset managers were on the right side of the move. The US dollar benefitted from hot CPI, Fed members pushing back on rate cuts and safe-haven flows from Middle East tensions.

Going forward, I now suspect large speculators will begin trimming shorts and adding to longs and flip to net-long exposure by the next COT report (assuming they haven’t already). My 106 target is now within easy reach, and a move to 108 seems feasible.

US Dollar, Yen, VIX, Gold, Crude Oil Analysis: COT Report_2

VIX futures positioning – COT report:

Middle East tensions weighed on Wall Street indices on Friday and sent the VIX briefly above 19 for the first day this year. The +2.3 point rise was its most bullish day since October, so it is interesting to note that asset managers and large speculators were trimming short exposure and adding to longs ahead of Friday’s move.

In fact, asset managers are on the cusp of flipping to net-long exposure to VIX futures for the first time since mid January. Yet just fur weeks ago, their net-short exposure was at the most bearish level since January 2020, just weeks ahead of the February 202 high all thanks to the pandemic.

I have conflicting thoughts over how to interpret this. Perhaps asset managers flipping to net-long exposure could indeed nail a market top and we finally see Wall Street indices correct by more than a few percent. Yet looking back through history, there have been many false signals when managers flip to net-long exposure, so perhaps we should wait for large speculators to also flip to net-long exposure before getting too excited over a larger drop for US indices.

US Dollar, Yen, VIX, Gold, Crude Oil Analysis: COT Report_3

JPY/USD (Japanese yen futures) positioning – COT report:

In July 2007 yen futures reached a record level of net-short exposure. And the recent break of key support which sent USD/JPY above 152 has seen net-short exposure break above the 2013 and 2017 cycle highs, and now within striking distance of the record high ~188 net short exposure. The break above 152 was significant, and there were even some clues from an MOF official that the need to intervene was not a strong as originally though. The next obvious level for traders to keep an eye on is 155 on spot USD/JPY prices, or 0.00646 on yen futures. Yes, yen futures could be at a sentiment extreme, but if there is no threat of intervention and US data continues to justify a stronger US dollar, then the path of least resistance for USD?JPY appears to be higher.

US Dollar, Yen, VIX, Gold, Crude Oil Analysis: COT Report_4

Gold futures (GC) positioning – COT report:

Gold futures rose for a fourth consecutive week and briefly traded above $2400 and formed a fresh record high. A bearish pinbar formed on the weekly chart to suggest bullish momentum is waning. But it is difficult to construct a particularly bearish case from this one candlestick alone. Large speculators and managed funds remain net long, but not by an extreme amount.

Asset managers decreased short exposure to gold by -9.4% (-7k contracts) and increased longs by 1.1% (+703 contracts), whereas large speculators increased long gold exposure by 15.7% (+10.1k contracts) and reduced shorts by -7.1% (-8.4k contracts).

And that means gold remains on the ‘buy the dip’ watchlist, even if dips may be shallow.

US Dollar, Yen, VIX, Gold, Crude Oil Analysis: COT Report_5

WTI crude oil (CL) positioning – COT report:

If you consider the headlines that were released from Friday and over the weekend regarding a potential Middle East conflict, crude oil’s reaction has been relatively subdued. IN fact, all of the action seemed to be on any market except crude oil, which sent US indices and commodity FX lower, gold and the VIX higher. It could be argued much of this has been priced in, given crude oil has risen ~30% since the December low.

Market positioning shows that large speculators and managed funds increased their net-long exposure for a second consecutive week. And like gold, exposure does not appear to be at a sentiment extreme. There was a slight increase of short bets among large speculators, but they may have since been removed given the headlines that were to follow after the COT data was compiled on Tuesday. And also like gold, WTI remains on the ‘buy the dip’ watchlist, as it is difficult to construct a convincing bearish case. Yet if oil is not rallying hard on Middle East headlines, it begs the question as to whether traders would be wise to indicate longs at these levels without waiting for a pullback first (unless tensions really do escalate).

US Dollar, Yen, VIX, Gold, Crude Oil Analysis: COT Report_6

Risk Warnings and Disclaimers

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Samantha Luan

Economic

Stocks

India’s ability to turn its economic expansion into corporate profits makes it a better prospect for investors than Japan or China, according to the latest Bloomberg Markets Live Pulse survey.

The powerful rallies in Indian and Japanese equities as China’s market has slumped have reset Asia’s financial-market landscape, providing global investors with three competing poles for regional allocations.

Even with China’s attractively low stock valuations, and Japan’s progress in improving corporate governance, almost half of 390 MLIV Pulse survey respondents selected India as the best investment among the three Asian giants. The survey is a vote of confidence in India Inc. as the world's largest democracy is headed to general elections carried out over seven phases from April 19 until June 1. ‘Expensive’ India Lures Investors Avoiding China Risks_1

‘Expensive’ India Lures Investors Avoiding China Risks_1

“There are many reasons to prefer expensive India equities over cheap China ones such as better transmission of GDP growth into earnings growth,” said Kieran Calder, head of equity research for Asia at Union Bancaire Privee in Singapore. A “better track record of delivering consistent earnings growth and supportive geopolitical environment” further bolster the case for Indian shares, he said.

Key stock indexes in both India and Japan have climbed to records this year following a rally driven by rapid economic growth in the case of India, and the gradual return of inflation, along with corporate reforms in Japan. Indian equities now trade at around 23 times next year’s expected earnings, exceeding even the US, and outpacing the 17 for Japan and about nine for China, according to data compiled by Bloomberg based on MSCI Inc.’s indexes.

The main gauge of Chinese equities has tumbled about 40% from its peak set three years ago as deflation and a rolling property crisis have weighed on the economy. More than half of the survey respondents said they expected China’s equity market to underperform India and Japan’s over the next 12 months.

Indian equities attracted $25 billion in net inflows for the year through March, compared with just $5.3 billion for China, according to data compiled by Bloomberg. The tailwinds behind Indian shares include the growing population and optimism the growing middle class will feed into higher corporate profits.

“India is the best market to own,” said Vikas Pershad, portfolio manager at M&G Investments in Singapore. Indian equities are likely to play a large role in regional benchmarks, he said.

Indian shares now make up 18% of the MSCI Emerging Markets Index. China’s 25% weighting is well down from its high of more than 40% a few years ago.

Infrastructure in India was highlighted as a particular bright spot in the survey by 41% of the respondents. The government of Prime Minister Narendra Modi has more than tripled its infrastructure allocation from five years ago to more than 11 trillion rupees ($132 billion) for the 2025 fiscal year. Modi is projected to invest 143 trillion rupees to modernize critical infrastructure in the six years through 2030.

India's infrastructure and capital goods bellwether Larsen & Toubro Ltd. is trading at a price-earnings ratio of about 30 times. At the same time, other firms such as PNC Infratech Ltd. and JSW Infrastructure Ltd. are still trading at or below their 10-year average valuations.

The South Asian nation has also fast emerged as an alternative to China for global manufacturing, with the likes of Apple Inc. beefing up its production facilities in the country.

Modi’s party faces a national election this year, and he has made India’s accelerating economy a major part of his pitch. He is expected to return as prime minister with a strong majority to deepen infrastructure investment and manufacturing. Should he lose, it may derail the infrastructure and manufacturing push. Investors don't seem concerned though, with more than four-fifths of respondents saying the impact of the elections on markets would be negligible or doesn’t concern them. ‘Expensive’ India Lures Investors Avoiding China Risks_2

‘Expensive’ India Lures Investors Avoiding China Risks_2

Japanese value stocks, typically larger and well established firms that trade at relatively cheap metrics, were also identified by more than a third of respondents as an attractive investment.

One of the main reasons for the rally in Japanese equities has been the corporate reforms pursued by the Tokyo Stock Exchange.

“Japanese companies are dealing with the TSE’s request seriously,” said Fumie Kikuchi, a research analyst at GMO in Singapore. “It means a lot that now corporate management speaks the same language that investors do.” ‘Expensive’ India Lures Investors Avoiding China Risks_3

‘Expensive’ India Lures Investors Avoiding China Risks_3

In China, meanwhile, slowing economic growth, the specter of deflation and the ongoing real-estate crisis are likely to deter investors, according to Adrian Zuercher, head of global asset allocation and co-head for global investment management APAC at UBS Global Wealth Management.

“There’s very little incentive to allocate to China," he said. "We're still in a deflationary environment, and as long as we don't seem to be trending upwards — which would create more revenue growth — there is very little appeal."

Source：Bloomberg

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Risk Warnings and Disclaimers

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Samantha Luan

Commodity

Forex

Stocks

US Equity Markets: Friday Losses and the Middle East

On Friday, US consumer sentiment numbers garnered investor attention. The Michigan Consumer Sentiment Index fell from 79.4 to 77.9 in April. Significantly, inflation expectations for the year ahead further impacted expectations of a June Fed rate cut. The Michigan Inflation Expectations Index increased from 2.9% to 3.1%.

On Friday, the Nasdaq Composite Index slid by 1.62%. The Dow and the S&P 500 saw losses of 1.24% and 1.46%, respectively.

The extended losses from Friday and news of Iran attacking Israel will set the tone for the Monday Asian session. A flight to safety could adversely impact buyer demand for riskier assets.

Asian Economic Calendar: Japan in Focus

On Monday, machine order numbers from Japan will draw investor attention. Economists forecast machine orders to decline by 8.0% year-on-year in February after falling 10.9% in January. Weaker-than-expected numbers would signal a weakening demand environment and impact export-listed stocks.

Moreover, investors should consider trade data from China. The numbers were available after the ASX 200 and Nikkei sessions on Friday.

Exports declined by 7.5% year-on-year in March after rising 5.6% in February. Imports decreased by 1.9% year-on-year after declining by 8.2% in February. The US dollar trade surplus narrowed from $125.16 billion to $58.55 billion.

The weaker-than-expected trade data contrasted with improving manufacturing PMI numbers from China. Additionally, the numbers could raise expectations of a stimulus package from Beijing.

Commodities: Crude Oil, Gold, and Iron Ore

Investors should consider commodity prices. The news from the Middle East could spike crude oil and gold prices. Concerns over supply disruptions would drive crude oil prices higher. A flight to safety could fuel demand for gold.

On Friday, WTI ended the session up 0.75% to $85.66. Gold spot fell by 1.19% to $2,344. Iron ore futures ended the session down 0.18% on the Singapore exchange.

The USD/JPY, the Intervention Zone, and the Nikkei

The USD/JPY remained within the intervention zone at 153.210 on Friday. Risk aversion could drive buyer demand for the Japanese Yen, favored over the US dollar. A pullback in the USD/JPY could impact buyer demand for Nikkei-listed export stocks.

ASX 200 Hang Seng Index, Nikkei 225, ASX 200: Flight to Safety After Iran Attack_1

The ASX 200 fell by 0.33% on Friday. Tech stocks cushioned the downside. The S&P ASX All Technology Index (XTX) gained 0.12%. However, bank, gold (XAU/USD), mining, and oil stocks contributed to the losses.National Australia Bank Ltd. (NAB) and Commonwealth Bank of Australia (CBA) declined by 0.44% and 0.49%, respectively. ANZ Group Holdings Ltd. (ANZ) and Westpac Banking Corp. (WBC) fell by 0.03% and 0.31%, respectively.Rio Tinto Ltd. (RIO) and BHP Group Ltd (BHP) saw losses of 0.27% and 0.91%, respectively. Fortescue Metals Group Ltd. (FMG) declined by 0.12%.Woodside Energy Group Ltd (WDS) and Santos Ltd (STO) fell by 1.27% and 0.38%, respectively.Gold stocks had a mixed session. Northern Star Resources Ltd. (NST) declined by 0.39. Evolution Mining Ltd (EVN) advanced by 0.51%.

Hang Seng Index Hang Seng Index, Nikkei 225, ASX 200: Flight to Safety After Iran Attack_2

On Friday, the Hang Seng Index slid by 2.18%. Property stocks and tech stocks contributed to the losses. The Hang Seng Tech Index (HSTECH) and Hang Seng Mainland Properties Index (HSMPI) ended the session down 1.81% and 3.78%, respectively.Tencent (0700) and Alibaba (9988) saw losses of 1.71% and 3.44%, respectively.Bank stocks also had a negative session. HSBC (0005) declined by 1.62%. China Construction Bank (0939) and Industrial Commercial Bank (1398) slid by 1.84% and 1.97%, respectively.

The Nikkei 225 Hang Seng Index, Nikkei 225, ASX 200: Flight to Safety After Iran Attack_3

The Nikkei advanced by 0.21% on Friday.Bank stocks ended the session in negative territory. Sumitomo Mitsui Financial Group Inc. (8316) and Mitsubishi UFJ Financial Group Inc. (8306) fell by 0.88% and 0.80%, respectively.However, it was a mixed session for the main components of the Nikkei.Fast Retailing Co. Ltd. (9983) bucked the trend, tumbling 4.40%.Sony Group Corporation (6758) and Tokyo Electron Ltd. (8035) rallied 1.44% and 1.49%, respectively. KDDI Corp. (9433) and Softbank Group Corp. (9948) gained 0.21% and 0.45%, respectively.

For upcoming economic events, refer to our economic calendar.

Source: FX Empire

Risk Warnings and Disclaimers

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Glendon

Economic

MeasurementInflation is a constant companion in the economic landscape. It impacts everything from grocery bills to wages, and understanding how it's measured is crucial for informed financial decisions. In the United States, two primary inflation metrics take center stage: the Consumer Price Index (CPI) and the Personal Consumption Expenditures Price Index (PCE). While both measure inflation, they have distinct characteristics and can yield slightly different results.

This article delves into the intricacies of the CPI and PCE indexes, exploring their methodologies, limitations, and implications for understanding inflation.

Decoding the CPI: A Household-Centric Lens

The Consumer Price Index (CPI) is a widely recognized inflation gauge. It reflects the change in the average price of a basket of goods and services purchased by urban consumers over time. The Bureau of Labor Statistics (BLS) meticulously calculates the CPI by:

Identifying a basket of goods and services: This basket represents the typical purchases of urban households, encompassing essentials like food and housing, as well as discretionary items like entertainment. The weights assigned to each category reflect their relative importance in household spending.

Tracking price changes: The BLS monitors the prices of these goods and services across a vast network of retail outlets throughout the country.

Calculating the average price change: By comparing current prices to a baseline period (usually the previous year), the BLS calculates the overall change in the basket's price.

The CPI serves as a benchmark for various economic adjustments, including wage negotiations, cost-of-living adjustments (COLA) for Social Security recipients, and even tax brackets.

Limitations of the CPI

Urban Focus: The CPI only considers urban consumer spending, neglecting the price changes experienced by rural populations.

Substitution Effect: The CPI doesn't fully account for consumer substitution behavior. If the price of one item rises, consumers might switch to a cheaper alternative. The CPI might overestimate inflation if this substitution effect isn't adequately captured.

Fixed Basket: The basket of goods and services is updated periodically, but there might be a lag in reflecting changing consumer preferences.

Unveiling the PCE: A Broader PerspectiveThe Personal Consumption Expenditures Price Index (PCE) offers a complementary perspective on inflation. It measures the change in the prices of goods and services consumed by all households in the U.S., including both urban and rural residents.

Additionally, the PCE considers:

Consumption funded by others: Unlike the CPI, the PCE incorporates the cost of goods and services purchased on behalf of consumers, such as employer-provided health insurance and government programs like Medicare.Durable goods: The PCE treatment of durable goods (items lasting more than three years) differs slightly from the CPI. The CPI reflects the full purchase price of a durable good, while the PCE considers the "consumption value" used over time.

The Federal Reserve's Preference

The Federal Reserve, the central bank of the U.S., closely monitors both CPI and PCE but often places greater emphasis on the PCE for its monetary policy decisions. The PCE is viewed as a more comprehensive measure of inflation, encompassing a broader range of consumer spending and potentially capturing substitution effects more effectively.

Understanding the Discrepancies: CPI vs. PCEWhile both indexes measure inflation, they can sometimes yield slightly different results. Here's a breakdown of the potential discrepancies:

Scope: The broader scope of the PCE, including rural spending and healthcare expenditures paid by others, can lead to a slightly lower inflation reading compared to the CPI, which focuses solely on urban out-of-pocket spending.

Basket Update Schedule: The CPI updates its basket of goods and services every two years, while the PCE updates it quarterly. This difference can affect how quickly each index reflects changes in consumer preferences.

The Takeaway: A Multifaceted View of InflationUnderstanding the nuances of both the CPI and PCE indexes empowers individuals to gain a more comprehensive understanding of inflation. While the CPI provides a widely recognized benchmark, the PCE offers a broader and potentially more accurate picture of inflationary trends. By considering both metrics, you can make informed decisions about your finances and navigate the economic landscape with greater confidence.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Thomas

Economic

Stocks

During the 1997/98 Asian financial crisis, US Federal Reserve chairman Alan Greenspan famously said that Asia got into trouble because it was mainly a bank-dominated financial system that lacked a "spare tyre". In American parlance, the spare tyre is the stock market, with the US stock market being the largest and deepest in the world, accounting for 47% of global market capitalisation (according to the World Federation of Exchanges).

American companies rely on the stock market and profits to fund their growth and less on the banking system. Which was why American companies and the US economy recovered faster after the 2008 global financial crisis than the bank-dominated European, Japanese and Chinese corporate sectors.

Here are some interesting facts. The Chinese economy grew three times faster in gross domestic product (GDP) terms (averaging 6% a year) than the American economy between 2012 and 2023 (averaging 2% a year), but its stock markets — the Shenzhen and Shanghai stock exchanges — grew 3.5% and 2.7% a year, with market cap growing 34% to 47%, respectively, over this period. The Nasdaq’s market cap grew 4.6 times, with the index growing 17% a year on average over this period.

By comparison, Hong Kong’s Hang Seng Index declined 1.2% on average over this period and the FTSE100 London also lagged at 2.7% growth a year. Japan has lagged in GDP growth, but the Nikkei 225 averaged 13.2% per annum over the last decade or so.

In essence, the US stock market added US$10 trillion to investor wealth in 2023, even though real estate prices, especially commercial real estate valuation, was flat. According to the latest Fed Flow of Funds accounts for end-2023, the foreign sector added US$2.7 trillion to their holdings of US equities at market value last year, which means that foreigners added in terms of new flows as well as share price gains.

The question we must ask therefore is whether growth is ultimately driven by the state (government), corporate, finance or household sectors? In the US, the state is a net absorber of resources, since the federal government’s net savings for 2023 was negative US$1.9 trillion, meaning it was a net dis-saver and borrower from the rest of the economy, including foreigners. The household sector is a net saver and also consumer that drives domestic growth.

The latest (December 2023) Flow of Funds data showed that the US corporate sector, plus Wall Street, is truly acting as the hedge fund of the world — it borrows through the US government’s large issuance of sovereign debt that commands a cost of roughly 3% to 4% per year for 10-year bonds. The returns on investments abroad by the corporate sector and households would be at least double to triple that. The US earned a net income from the rest of the world of around US$160 billion to US$180 billion per year between 2021 and 2023.

Unlike bank-dominated systems, US corporations run on a low debt-to-equity ratio of between 19% and 27%. Bank-dominated corporates in Asia typically run debt-to-equity ratios of 50% or above. Having shifted production outside the US, American corporations are concentrating on asset-light strategies where the return on equity (ROE) is higher. Non-financial assets account for just under 40% of total assets, of which intellectual property rights have risen by US$521 billion between 2021 and 2023 to US$3.55 trillion, or 7.2% of total corporate assets at end-2023. In other words, US corporations focus on research and development in software, rather than just production of hardware.

The bottom line is that if US corporations continue to drive profits and the monetisation of their technology (especially artificial intelligence, or AI) whereas the rest of the world stays in the old economy (agriculture, manufacturing), the rest of the world will still be investing in the US stock market, and pay annual software charges to the Magnificent Seven, which will concentrate on top AI software, chips, data centres and smart equipment. Sounds like a Microsoft model of new tech development?

As military historian Yuval Noah Harari says, the ultimate aim of AI is the mental colonisation of the users. If the rest of the world believes and is willing to pay for American ideas and concepts, the American business model will be the top dog for years to come.

What are the implications for economies like Malaysia?

Bursa Malaysia’s Composite Index was 1,530.73 at end-2011, not much different from the current level of 1,550. During this period, the Malaysian economy grew twice as fast as the US economy (4% to 5% versus 2% per annum) and yet our stock market has been flat. As explained above, the US stock market is purely private led, whereas the Malaysian stock exchange is dominated by government-linked companies. These account for 36% and 54% of Bursa Malaysia’s market cap and the Kuala Lumpur Composite Index respectively.

Therefore, we need to ask — is the current corporate strategy for the country as a whole sustainable? If Malaysian listed corporations continue to lag in profitability (ROE) and with the ringgit depreciating against the US dollar, is the economy dragged down by the performance of the corporate sector, and why? After all, a depreciating ringgit actually gives Malaysian corporate exporters higher revenues in ringgit terms.

The answer is clearly very complex, but using the US model as a benchmark, we need to rethink whether we should concentrate on knowledge-based growth, rather than commodity (oil and gas, and palm oil) earnings. Technology is well accepted as the way forward, especially how we can use AI to improve total factor productivity (TFP).

Will the state or the corporate sector lead this AI/TFP revolution or transformation? Other emerging markets are clearly thinking through these issues, with India, Singapore, South Korea and Taiwan taking the lead. In short, if the corporate sector does not take the lead in AI and ESG (environmental, social and governance) transformation, expect the stock market to underperform even GDP growth.

Source: The Edge Malaysia

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Risk Warnings and Disclaimers

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ING

Economic

Recent growth pace has returned to pre-Covid norm

Indonesia's economy grew by 5.05% in 2023, with growth returning to the pre-Covid norm of roughly 5% of expansion. Household consumption remained a key support for overall economic activity, delivering a healthy 4.5% year-on-year gain, while government spending also managed to contribute to the rise in economic activity. Meanwhile, capital formation was a modest surprise as it managed to expand despite elevated borrowing costs. On the other hand, net exports delivered a less potent push with global demand for the country's exports waning.

We predict that growth will remain positive this year, slightly above average at 5.2% YoY. The recent intensification of global headwinds, however, could pare this estimate closer to the pre-Covid average of roughly 5% YoY should threats prove persistent.

Flare up in inflation to derail growth?

Household spending has been a major contributor to growth, and we could see a modest boost coming from election-related spending for the first quarter 2024. We've noted a brief improvement in Bank Indonesia's (BI) retail sales survey for February, which was up 3.6% YoY, coinciding with the national election and subdued core inflation.

The recent pickup in price pressures could, however, be a potential headwind for the economy, with both headline and core inflation inching up to start 2024. BI has flagged a potential flare up for inflation due to faster food and energy inflation. Unfortunately, the reacceleration in inflation is happening at a time when the central bank lowered its official inflation target band to 1.5-3.5% (from 2-4% in 2023). Indonesia's Growth Momentum Hinges on Export Recovery_1

Indonesia's Growth Momentum Hinges on Export Recovery_1

Retail sales have been largely flat even ahead of inflation rebound

Retail sales have been in expansion, but have been largely flat even during a period of subdued inflation. One exception was spending on communications, which dipped in late 2023 before recovering sharply at the start of the year possibly due to the availability of lower-priced handsets and service plans.

In the coming months, the El Nino weather phenomenon will likely ensure food costs are elevated while the recent increase in crude oil prices could also fan price pressures. Should inflation continue to accelerate in the coming months, we may see retail sales and overall household spending weighed down by higher prices as consumers adjust to faster inflation. Indonesia's Growth Momentum Hinges on Export Recovery_2

Indonesia's Growth Momentum Hinges on Export Recovery_2

Export struggles have been pronounced

Once a source of stability and growth, Indonesia's export sector has struggled due to softer global demand and lower global prices for top export commodities. Furthermore, the strong performance of the economy's export sector powered a record wide trade surplus in 2022, which provided support for the IDR with the currency displaying resilience during those periods due to the strong dollar inflows.

More recently, exports have struggled. Almost all subsectors have contracted, with both the fuel and lubricants and animal and vegetable oils subsectors falling the most. The stark drop in the international price for both coal and palm oil, coupled with a decline in global demand, resulted in the almost eight-month decline.

Should demand for Indonesia's commodity exports improve while global prices remain elevated, we could see a decent recovery for the export sector in 2024. Meanwhile, the recent rise in global prices for both coal and palm oil could boost export receipts further if prices remain on an uptrend. Indonesia's Growth Momentum Hinges on Export Recovery_3

Indonesia's Growth Momentum Hinges on Export Recovery_3

Industrial production feels heat from softer export numbers

As mentioned previously, the fate of Indonesia's export sector has a direct link to other sectors in the economy, such as the industrial sector. Strong exports recorded between 2021 and 2022 translated to a similar rise in industrial production during the same period. Because of the struggles of the export sector last year, we've seen a similar decline in industrial production as manufacturing slowed considerably once demand for Indonesia's exports dried up.

For 2024, we can say that any potential recovery for industrial output will be tied to a similar improvement in prospects for the country's export sector. Indonesia's Growth Momentum Hinges on Export Recovery_4

Indonesia's Growth Momentum Hinges on Export Recovery_4

External outlook no longer as resilient

Indonesia's current account balance has managed to eke out months of surplus by virtue of a sustained run of trade surpluses. However, with the trade surplus now much more modest – averaging $3bn a month in 2023 and down to $867m as of February – the support it provided previously has diminished somewhat. Indonesia's current account surplus has waned from $15.3bn in the first quarter of 2023 down to a deficit of $1.6bn by the end of 2023, according to Bank Indonesia.

With the outlook for the export sector positive but not overly optimistic, we can expect the trade surpluses and the current account in deficit, which should mean limited support for the IDR – if any at all. We therefore expect the currency to come under pressure for most of the year, with the IDR likely to lag any potential rally by regional peers. Indonesia's Growth Momentum Hinges on Export Recovery_5

Indonesia's Growth Momentum Hinges on Export Recovery_5

Bank Indonesia rate cuts in 2H?

BI Governor Perry Warjiyo has remained balanced in his assessment of the current monetary policy stance. Inflation has, for the most part, remained contained. However, risks remain tilted to the upside and the lower target could force BI to remain prudent for now.

On top of the inflation threat, the loss of support coming from the current account surplus will also likely convince BI to maintain interest rate differentials to help ensure IDR stability and offset the sharp narrowing of the trade surplus.

We therefore believe that any BI easing may only take place in the second half of the year, with the central bank opting for a more shallow reduction of up to 50bp worth of rate cuts. The main determinant for the timing of BI cuts, however, remains tied to IDR stability. We only see the central bank easing when pressure on the IDR is minimal.

Fiscal consolidation ahead of schedule

Indonesia's fiscal metrics continued to improve, with the deficit-to-GDP ratio falling sharply to 1.7% last December 2023, lower than the target of 2.3% for the year. Indonesia had previously planned to bring the deficit-GDP ratio back below 3% by 2024, but robust economic performance helped restore revenue streams. Meanwhile, pressure on fiscal support to the population has receded, resulting in the improved fiscal position. Indonesia's Growth Momentum Hinges on Export Recovery_6

Indonesia's Growth Momentum Hinges on Export Recovery_6

Enter Prabowo, eye on fiscal sustainability

Defence Minister Prabowo Subianto was recently proclaimed the official winner of the 2024 election, and he will have the task of proving that he was indeed a continuity candidate. One of Prabowo's campaign promises was to provide free lunch to students and teachers, fuelling concerns over the fiscal sustainability of such a programme.

Prabowo attempted to alleviate these concerns, vowing to maintain fiscal discipline during a televised speech after his election win was apparent. Economic Minister Airlangga Hartarto indicated the incoming president would strive to maintain pre-set targets for both public debt (60% of GDP) and the budget deficit ceiling (3% of GDP). This year, the deficit to GDP ratio will likely hit 2.8% of GDP, with next year's projection expected to settle between 2.5-2.8% of GDP.

An early test for incoming President Prabowo's governance would be his ability to fulfill his campaign promises (such as the free lunch programme) while still ensuring fiscal sustainability. Maintaining fiscal discipline will be key to safeguarding investor sentiment as improved fiscal metrics remain a key factor in supporting the positive outlook for the economy.

Overall 2024 outlook

The baseline growth outlook for Indonesia is positive overall, with household spending expected to remain healthy as inflation stays within target despite a projected acceleration in the first half of the year.

Subdued inflation should be supportive of consumption, while capital formation could remain robust as bank lending sustains double digit growth as of February 2024. For the rest of the year, we will be keeping our eye on two key factors that could determine whether economic growth can hit our projected 5.2% YoY rate.

The first is the performance of the export sector given its substantial link to other sectors in the economy, such as the industrial sector. A renewed pickup in exports should be positive for Indonesia's industrial sector while also providing added stability for the IDR.

Secondly, we will be keeping a close watch on fiscal sustainability in particular once Prabowo begins his term. The current healthy state of the fiscal balances has been a key driver of positive sentiment towards Indonesia, and a quick deterioration could spark concerns about the fiscal sustainability of the economy.

In terms of financial markets, we expect Bank Indonesia to extend its pause well into the year, with potential rate cuts only coming about in the second half of the year. BI will prefer to maintain interest rate differentials to compensate for the now smaller trade surpluses. This means that borrowing costs and local bond yields could stay elevated in the near term, while the IDR remains on the backfoot until the projected rebound in exports can push the trade surplus back to more substantial levels.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Thomas

Economic

Forex

Far from cementing itself as a world reserve currency, China's yuan has gone into reverse and its share of global foreign exchange reserves has fallen to the lowest level in three years.

The gradual but steady decline since early 2022 reflects the international community's unease about investing in China, which was crystallized in huge foreign capital outflows from Chinese equity and bond markets last year.

While China's economy finally seems to be emerging from its post-lockdown funk in the wake of COVID-19, there are plenty of reasons reserve managers may still need convincing to start re-loading up on the renminbi, or yuan.

China is a global economic and financial superpower, and the yuan's role in cross-border trade and transactions is rising. But there are questions over its economic might, unease over its capital controls, and concern over its geopolitical alliances and militarism.

The yuan's allure as a global reserve currency is fading.

China Yuan's Global FX Reserve Footprint Smallest in 3 Years_1

The International Monetary Fund's latest composition of foreign exchange reserves (Cofer) data show that of the world's $11.45 trillion in FX reserves where the currency breakdown is known, 2.29% was in renminbi at the end of last year.

That is the lowest share since the fourth quarter of 2020, and down substantially from the 2.83% peak in the first quarter of 2022.

Central banks and reserve managers around the world have reduced their yuan allocation in each of the last seven quarters. In nearly two years, the yuan share of their FX reserves has shrunk by a fifth.

Michael Cahill, an FX strategist at Goldman Sachs in London, notes that Chinese government bonds no longer offer reserve managers the yield premium over developed world bonds that they did when the IMF first included the yuan in its Cofer data in 2016.

And it's no coincidence that the Chinese currency's FX reserve footprint began to shrink in the first quarter of 2022, when Beijing's ally Russia invaded Ukraine.

"It is also certainly possible that geopolitics have played a role. Academic literature has found that reserve management is in part dictated by geopolitical alignment, and that certainly seems consistent with what we have seen," Cahill says. China Yuan's Global FX Reserve Footprint Smallest in 3 Years_2

China Yuan's Global FX Reserve Footprint Smallest in 3 Years_2

Clear Trend

Of the 10 countries that regularly report a geographic breakdown of their reserve holdings, none have increased their yuan holdings since the first quarter of 2022.

While these detailed reports represent only a small fraction of global reserves, Cahill reckons their stance on the yuan signals a "notable shift" in FX reserve management.

Visibility around Russia's FX reserves dimmed after the invasion of Ukraine. But at the end of 2021 Russia was the largest holder of yuan reserves, with around a third of all internationally held yuan-denominated reserves, according to analysts at ING.

They also reckon Moscow may have reduced that stash after the invasion as it had to sell reserves to finance its ballooning budget deficit.

On the other hand, some smaller countries outside of the 149 nations included in the IMF's Cofer data set may well have increased the yuan-denominated share of their FX reserves in the last couple of years.

China Yuan's Global FX Reserve Footprint Smallest in 3 Years_3

In short, it is hard to measure FX reserves flows with real certainty but as ING points out, the general picture is clear - the renminbi is only one of two currencies, along with the euro, whose share of global FX reserves fell over the 2022-23 two-year period.

This is an unequivocal reversal from the yuan's early days as a global reserve currency. The IMF's Cofer data show its first share of reported FX reserves at the end of 2016 was 1.08%, which nearly tripled to a peak of 2.83% in early 2022.

In nominal terms, yuan-denominated FX reserves started at $90.8 billion and reached a high of $337.3 billion in late 2021. They ended last year at $261.7 billion.

The yuan's share of reserves is falling in exchange rate-adjusted terms too, according to Goldman Sachs. They also hit a three-year low at the end of last year, although the decline has been more gradual and the previous peak was not as high.

Reserve managers tend to be conservative, and changes in currency allocations tend to be gradual. That's because managers tend to lean against exchange rate moves in order to keep their make up of their reserves stable - that is, they buy more of a currency when it is weakening.

But according to analysts at JP Morgan, the yuan has been the "clearest exception" to this rule recently. Diversification away from the yuan has continued despite the currency's 10% slide against the dollar in the 2022-23 period. China Yuan's Global FX Reserve Footprint Smallest in 3 Years_4