Interest rate advantage + policy room Indonesian bonds may become the biggest winners of the US Federal Reserve's rate cuts.

As expectations of a Federal Reserve rate cut continue to rise, the Asian bond markets are generally bullish, with Indonesian bonds expected to be the biggest winner. As one of the highest yielding sovereign bonds in Asia, the Indonesian benchmark bond yield is close to 6.5%, which will make Indonesian rupiah-denominated bonds particularly outstanding. Of particular note is that the Indonesian central bank is one of the few central banks that have exchange rate stability as a core policy objective, which means it can further ease monetary policy with the weakening of the US dollar without worrying about currency depreciation pressures. Rajeev De Mello, portfolio manager at Geneva's GAMA Asset Management, said, "Against the backdrop of a weakening US dollar, Asian local currency bond markets, especially the Indonesian market, will benefit significantly. Indonesian bonds currently hold a significant weight in our allocation of emerging market local currency bonds." With the increasing correlation between the US dollar and the Indonesian rupiah exchange rate and the local 10-year bond yield (the correlation has now reached the highest level since July 2024), a weakening US dollar will help drive the appreciation of the Indonesian rupiah, further lowering bond yields. On Monday, Indonesia's 10-year bond yield fell by 9 basis points, marking the largest decline in emerging Asian markets. This trend followed a drop in US Treasury yields on Friday, when weaker-than-expected nonfarm payroll data significantly increased the likelihood of a Fed rate cut next month. Due to narrowing spreads, Indonesian rupiah-denominated bonds are becoming increasingly sensitive to US Treasury yield fluctuations. Currently, the spread between Indonesian and US 10-year bond yields is around 220 basis points, 1.1 standard deviations below the five-year average level. Goldman Sachs strategists Danny Suwanapruti and Xinquan Chen wrote in a report on Monday, "There is indeed potential for Indonesian rupiah-denominated bonds to rise, but they need US bonds to first open the upward channel." While market concerns about expanding fiscal deficits continue to constrain Indonesian bond performance, expectations of a rate cut by the central bank are expected to partially alleviate these pressures. Additionally, after experiencing its largest decline since February in July, the Indonesian rupiah rebounded in August, which also cleared the way for the central bank to cut rates. Bank Indonesia Governor Perry Warjiyo reiterated last week that after lowering rates by 75 basis points so far this year, the bank still has room for further rate cuts. De Mello of GAMA stated that the Federal Reserve's restart of a loose policy cycle will provide room for policy alignment by Bank Indonesia. "We expect Bank Indonesia to implement at least two more 25 basis point rate cuts by the end of the year."