December 01, 2024

Intensified War

Market Commentary

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In today's complex and tension-filled world, wars are no longer just fought on battlefields with guns and tanks. Conflicts have evolved into multidimensional struggles involving economies, technology, information, and even ideologies.

U.S, as a global superpower, is at the center of various conflicts with other major nations like Russia, China, and their allies.

For example, the U.S.-Russia conflict extends beyond the battlefield in Ukraine. It encompasses economic sanctions, a technological arms race, and digital propaganda wars.

Similarly, U.S.-China relations are strained, especially in trade and technological dominance. Meanwhile, other nations with regional and global interests are resisting U.S. hegemony, creating new dynamics in the global order.

Recently, Donald Trump addressed the idea of BRICS nations (Brazil, Russia, India, China, and South Africa) moving away from the U.S. dollar.

Trump declared that the U.S. cannot allow BRICS to create a new currency or support any alternative that could challenge the dollar’s dominance. He proposed imposing a 100% import tariff and barring BRICS countries from accessing the U.S. market if they pursued such actions.

On the financial front, an unusual phenomenon has emerged in the U.S. Treasury market. Following the Fed's interest rate cut in September, UST yields would typically decline. However, the 10-year UST yield surged by 70 bps from September to November, reaching 4.40%.

Despite the Fed's rate cuts, markets anticipate rising inflation due to aggressive fiscal policies expected after Donald Trump’s 2024 election win. This has driven UST yields higher.

Our analysts have examined the potential risks of prolonged UST yield increases.

Rising yields push up borrowing costs, which can hurt household consumption, business investment, and the housing market. Higher government debt servicing costs reduce fiscal flexibility, while a stronger dollar worsens the trade deficit by lowering net exports.

The analysis indicates that a 1% increase in UST yields could reduce U.S. annual GDP growth by 0.5%-1.0%. Household consumption may drop by 0.2%-0.3%, business investment by 0.5%-1.0%, and net exports by 0.15%-0.3%.

To stabilize the economy, the Fed might intervene to control Treasury yields. Possible measures include temporary bond purchases or implementing yield curve control to cap long-term yields. The Fed could also reduce the treasury general account balance from USD 800 bn to USD 100-USD 200 bn before January 2025, similar to quantitative easing, boosting market liquidity.

In extreme scenarios, the Fed may halt quantitative tightening and resume bond purchases next year. However, this carries risks of inflation and undermining policy credibility.

The Fed faces a tough dilemma: control inflation or support economic growth. If market pressures persist, intervention may become inevitable.

A decline in UST yields signals a global interest rate drop, creating opportunities for emerging markets like Indonesia.

With higher yields, Indonesian government bonds are increasingly attractive to global investors. Rising demand for these bonds pushes their yields lower. Additionally, a weaker USD, as foreign capital flows into emerging markets, further enhances Indonesia's appeal.

If this trend continues, Indonesia's 10Y government bond yield could approach 5.0% by 2025. This not only ensures local financial market stability but also strengthens Indonesia's position in the eyes of global investors.

Foreign capital inflows could also boost the stock market, particularly in sectors like banking, property, and infrastructure, which benefit from low interest rates.

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