Rupiah Gains on Capital Inflows and MSCI Optimism

Key Moments

Rupiah Advances as MSCI Keeps Indonesia in Emerging Market Category

USD/IDR is giving back ground during Asian hours on Thursday, trading near 17,970 after rising for three consecutive sessions. The pullback in the pair reflects renewed strength in the Indonesian Rupiah (IDR), as domestic market sentiment improves.

The positive tone in Indonesian assets follows a decision by global index provider MSCI to postpone any move to downgrade Indonesia’s equity market to frontier status until November. That delay allows Indonesia to maintain its emerging market classification for now, providing a supportive backdrop for the Rupiah.

Foreign Capital Inflows Bolster Indonesian Assets

Further underpinning the currency, Bank Indonesia (BI) has reported robust foreign capital inflows into domestic fixed-income markets. According to BI, funds flowing into government bonds and the central bank’s one-year SRBI instruments have totaled roughly IDR 105 trillion so far in June.

Dollar Eases After Recent High, But Policy Expectations Provide a Floor

The move lower in USD/IDR is also being driven by a softer US Dollar (USD). The Greenback has edged lower after touching a 13-month peak of 101.80 on Wednesday, as demand for safe-haven assets eased following reports of progress in US-Iran peace negotiations.

Despite the pullback, the downside for the Dollar may be constrained as expectations for tighter US monetary policy gain traction. Traders are positioning for potential Federal Reserve interest rate increases later this year, following hawkish commentary from Federal Reserve Chairman Kevin Warsh. He reiterated a strong focus on bringing inflation under control and observed that the broader US economy remains stable.

Reflecting these expectations, the CME FedWatch tool shows that market participants are assigning an 83.1% probability to rate hikes by the end of December.

Focus Turns to US PCE Inflation Data

Investors are now watching the upcoming release of US Personal Consumption Expenditures (PCE) data later today for further direction on the Dollar. Headline PCE inflation is expected to rise from 3.8% year-over-year in April to 4.1% in May, while core PCE is projected to tick up to 3.4%. The figures are likely to play a pivotal role in shaping the next move in the Greenback and, by extension, USD/IDR.

Understanding Risk Sentiment and Market Behavior

In the world of financial jargon, the two widely used terms “risk-on” and “risk-off” refer to the level of risk that investors are willing to stomach during the period referenced. In a “risk-on” market, investors are optimistic about the future and more willing to buy risky assets. In a “risk-off” market, investors start to ‘play it safe’ because they are worried about the future, and therefore buy less risky assets that are more certain of bringing a return, even if it is relatively modest.

Key Assets to Watch for Risk Sentiment

Typically, during periods of “risk-on”, stock markets will rise, most commodities – except Gold – will also gain in value, since they benefit from a positive growth outlook. The currencies of nations that are heavy commodity exporters strengthen because of increased demand, and Cryptocurrencies rise. In a “risk-off” market, Bonds go up – especially major government Bonds – Gold shines, and safe-haven currencies such as the Japanese Yen, Swiss Franc and US Dollar all benefit.

Currencies That Tend to Benefit in Risk-On Conditions

The Australian Dollar (AUD), the Canadian Dollar (CAD), the New Zealand Dollar (NZD) and minor FX like the Ruble (RUB) and the South African Rand (ZAR), all tend to rise in markets that are “risk-on”. This is because the economies of these currencies are heavily reliant on commodity exports for growth, and commodities tend to rise in price during risk-on periods. This is because investors foresee greater demand for raw materials in the future due to heightened economic activity.

Currencies That Tend to Benefit in Risk-Off Conditions

The major currencies that tend to rise during periods of “risk-off” are the US Dollar (USD), the Japanese Yen (JPY) and the Swiss Franc (CHF). The US Dollar, because it is the world’s reserve currency, and because in times of crisis investors buy US government debt, which is seen as safe because the largest economy in the world is unlikely to default. The Yen, from increased demand for Japanese government bonds, because a high proportion are held by domestic investors who are unlikely to dump them – even in a crisis. The Swiss Franc, because strict Swiss banking laws offer investors enhanced capital protection.