UBS INDO: significant selloff in bonds and MSCI Indo overnight - interesting trading day ahead!

We expect Indo equities to have a rollercoaster day today:

1. The bond market sold off aggressively overnight (chart below) with bond yields rising to above 9% 

In and of itself, such a move is not out of the ordinary in the illiquid Indonesian bond markets. However, there are other market moves afoot….

2. There was a major selloff in the iSHARES MSCI Indo ETF last night, closing down 5% on record volume (chart below)

Note: Our order pad shows no sell side flow of note – this ‘sell off’ is not yet broad-based. 

3. What triggered the sell off in bonds and the ETF overnight?

There does not seem to be a clear trigger to these market moves – it may simply be that the selloff in the bonds market triggered a fund (or funds) to aggressively hedge their Indo equities exposure.

Another theory is that a surprise rate cut in Turkey overnight, where the central bank is also perceived to be ‘behind the curve’ on inflation and is reluctant to cut rates as it battles inflows. Turkey, Indo and India have been grouped together as the inflation trade of late, and our team suspect that they made be part of a correlated ‘inflation’ macro basket trade.

As ASEAN economist Ed Teather put it:

“Indonesia is a proxy for the inflation trade at present.”

4. How does the UBS team feel about the bond market at present?

We’ve argued before that in this inflation-focused environment, equities will take their lead from the bond market. Accordingly, we look to our rates strategist Sid Mather for his thoughts:

·         Indo bond selloffs are always ugly, big crowd/small door and all that. Positioning is still very heavy, so this selloff can easily extend several more days. What is needed, I think is for (1) CPI readings to drop in line with yesterday's guidance (see below), and (2) for BI to demonstrate a sensitivity to investor concerns. The next BI meeting is Feb 4, so until then expect bond markets to stay nervous.

·         Medium term, support for Indo could come from: (1) lower CPI, as mentioned above, (2) 'sensible' BI rhetoric, (3) strong exports growth, to ease fears of a rapid current account deterioration, (4) BI putting to good use the FX reserves it has accumulated, (5) debt management office highlighting the fiscal flexibility they possess (large cash surplus), and (6) any demonstration that the 'bond stabilization fund' is credible.

While Sid feels value is emerging, Ed Teather thinks that at 9% yield, Indonesia becomes attractive.

5.  Steps in the right direction: Whisper inflation number is positive, administrative measures announced

The statistics bureau yesterday said that it expects softer CPI inflation in Jan vs. Dec (indicatively 6.6%y/y vs. 7%) and reducing price pressures from the start of the harvest season in Feb and Mar.

Also yesterday, the government removed tariffs on 57 imports of food related products to mitigate commodity price increases. Categories include wheat, soy bean, fertilizer raw material and animal feed raw material. The measures will see tariffs fall from an average 5% to zero for 1 year and will be effective from 1 Jan 2011