FxWirePro: Fair interpretation of rise in FX reserve and stable currency – Uphold NDFs as optimal IDR hedging

If a currency remains extremely stable, and the FX reserves are picking up, what does it indicate? Well, the most likely answer would be: there is an intervention from the central bank. This happened to IDR in the first three quarters of this year. USDIDR was pretty stable while the FX reserves held by the Bank Indonesia (BI) continued to rise. This phenomenon suggests that the central bank buys USD (and sells IDR) from the market to stabilize its currency amid capital inflows.

As a result, the central bank has accumulated more foreign reserves, which is critical for a vulnerable economy such as Indonesia. The stability, on the other hand, provides a decent opportunity to the foreign bond investors – they can enjoy the higher yields in IDR-denominated bonds, bearing manageable FX risks.

As a country with current account deficits, the foreign inflows are also quite important for Indonesia to finance its shortfalls. Interesting, things appear to have changed a little bit recently, as there have emerged remarkable capital outflows from the onshore bond market, resulting in a depreciation of IDR. However, it seems that the BI has been used to this: past experience suggests that foreign investors tend to offload some of the bond holding in Q4, and re-enter the market at the beginning of next year. Hence, the central bank is unlikely to intervene to strengthen its currency when the market volatility is deemed as “normal”.

Against a favorable EM backdrop, we don’t see USDIDR meaningfully below 13,100 given BI’s policy bias unless there is a big EM risk-on phase. Bonds are expensive on our macro fair-value model but the global hunt for yield and positive external position prevents a correction.

IDR, SGD, TWD and CNH all screen as decent ratio USD put buys; CNH is the most preferred candidate of the four given a known policy dimension to aid the case of directional strength over and above pure carry considerations.

We had advocated longs in USDKRW NDFs with a view to arresting upside risks, if you look at the technical chart of this pair, you could very well understand the performance of this hedging call. So, we still wish to remain long in USDIDR NDFs of 3m tenors at 13325, we see upside risks upto 13600 and a stop at 13118. The time horizon is 1-3 months and positive carry is approximately 2bp/month.