Company Update

12 Januari 2022

Macro & Market Perspective - January 12,2022

Anticipating FFR Hikes : Favor Stock over Bond


The Hawkish Fed

Embarking 2022, markets anticipate earlier rate hikes from the Fed. Persistently higher inflation and improving job market are the main driver for the Fed to take a hawkish stance. The US CPI is projected to rise 7.0% YoY in Dec-21, marking 4 decades high. Meanwhile the unemployment rate fell to 3.9% last month, the lowest level since Mar-20. FOMC’s participants seemed to agree that interest rate hikes is needed to fight inflation besides the tapering. Furthermore the Fed’s officials also consider to normalize its balance by reducing bond.

The Fed itself sees that inflation is more persistent than they previously thought. PCE inflation is projected to increase 5.3% in FY21E according to the Fed’s summary of economic projection, well above CB’s target of 2% and Sep-21 forecast of 4.2%. Inflation is estimated to normalize in FY22F to 2.6%. However the figure remain above CB’s target and previous forecast at 2.2% (Exhibit 1).

Therefore FOMC’s participants see 3x FFR hikes are likely in 2022. This depicted more aggressive US central bank as at Sep-21 projection the Fed was expected to increase benchmark policy rate only 1x. Some US banks even foresee 4x hikes this year. Fed’s first tightening cycle is expected to start as soon as Mar-22 with 77% probability of 25-50 bps target range (Exhibit 2). A more hawkish Fed has caused turmoil both in equity and bond market as 10-year UST yield is nearing 1.80%.

US policy normalization is thought to have a bad impact for financial assets particularly in emerging countries. Massive outflows have caused emerging market asset prices to fall and its currency to depreciate against USD. In this report we tried to dig deeper the influence of US monetary policy cycle on financial assets behavior (stocks & bonds) in emerging and developed nations from historical perspective.


Historically stocks were less sensitive to monetary policy cycle than government bond

Our sensitivity model has shown that government bonds were more sensitive to changing interest rates than stocks in the last two decades. The prices of government bond in developed and emerging markets suffered from rising interest rates as indicated by positive yield change (Exhibit 3). We see strong correlation between US and Hong Kong government bond yields with the FFR. We also noted that global stock return were negatively correlated with FFR. However the correlation of stock returns and FFR change was somewhat weak (Exhibit 4).

The cross countries analysis as shown in Exhibit 4 also indicate country’s stock markets (Europe & UK) that have high correlation to US market suffer more from Fed’s monetary tightening. While countries with low correlation to US stock market and global equities such as China can absorb the shock better.

Some emerging countries stock market such as Argentina, Thailand and Philippine were also more affected by global monetary policy. Indeed we understand that this may be associated with countries specific risk such as chronic high inflation and political stability that may escalate the downside risk and triggering foreign outflows.


Looking forward, the impact of Fed’s policy normalization on global financial market will vary across countries and sectors. The degree of magnitude will also depend on how effective the Fed communicate their policy to the market. Any unanticipated surprise is likely to trigger shock.


Indonesia : Betting on Economic Recovery & Higher Growth Lead Us to Favor Equities over Bond

Fed’s tapering 2013 gave us a clear picture that how US monetary policy normalization affect domestic financial market. Bernanke’s speech on plan to rollback liquidity injection surprised market sending UST yield higher and stock price to plummet. At that time JCI dropped, 10-year Indo GB yield rose and IDR suffer from depreciation against the greenback. However domestic stock market recovered faster while government bond yield keep rising.

We noted at least in the last 2 decades, domestic stock performance has shown to be less sensitive to Fed’s monetary policy compared to government bond. The correlation value between stock returns and FFR was negative but weak (R=-0.07).

Indeed that past performance does not necessarily predict future results. However we see that domestic financial market fundamental is strengthening and better than in nearly a decade ago. Therefore, we believe Indonesia is more prepared to face Fed’s tightening agenda this year.

We expect ample FX reserves will help cushion IDR from large depreciation. While potentially lower budget deficit and MoF-BI coordination through SKB-III should be translated to lower government bond supply risk. Combined with benign inflation outlook and rising domestic investors, this should help limit the upward pressures on government bond yield. Yet, we still like equity over bond on the back of economic recovery and higher growth that may further lower stock-bond correlation. We expect Indonesia’s GDP to expand 4.9-5.3% in FY22F. Our regression analysis showed that GDP significantly influenced EPS and JCI. Our baseline scenario for FY22F : JCI target at 7,150 (+15% EPS/16.4x PE) and 10-year Indo GB yield at 6.77% (Exhibit 5).


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