IDR likely to rally further towards 14,000 on the Powell Put as risk of Chinese yuan depreciation remains limited, says Scotiabank

The Indonesian Rupiah is expected to rally further towards 14,000 on the Powell Put as the risk of a sharp depreciation in the Chinese yuan is limited ahead of the G-20 Osaka Summit, while the USD/CNY will remain broadly stable during this period, with the People’s Bank of China (PBoC) keeping currency fixing below 6.90, according to the latest research report from Scotiabank.

The Bank Indonesia’s (BI) real policy rate remains elevated, although it declined somewhat to 2.68 percent with Indonesia’s CPI inflation rising to 3.32 percent y/y in May from 2.83 percent y/y a month ago.

The central bank is expected to stand pat on monetary policy for now to ensure the IDR stability. Going forward, it will likely raise expectations of BI rate cuts if external uncertainties such as US-China trade tensions start to ease and diminish, the report added.

According to CFTC data, non-commercial investors have been cutting their net short positions in the EUR and JPY persistently on rising odds of future Fed rate cuts. Fed Funds Futures contracts are now pricing in a 24 bp rate cut at the July 30-31 FOMC meeting.

The Powell Put, the market’s insurance that the Fed will act to stimulate the markets if necessary, is expected to weigh on the DXY Index with falling 10Y UST yield, while propping EM Asian currencies including the IDR as long as the Chinese yuan is stable.

The IDR has been running a tight correlation with the 10-year Indonesian government bond yield and remains vulnerable to capital flight as portfolio investment inflows play a substantial role in financing Indonesia’s current account deficit and can be withdrawn at a short notice, Scotiabank further noted in the report.

Meanwhile, according to Bloomberg data, foreign investors are now holding about 38 percent of total outstanding Indonesian government bonds.