Rupiah Advances as Softer Fed Outlook Weighs on US Dollar

Key Moments

Rupiah Gains as USD/IDR Retreats

USD/IDR is giving back part of its prior advance, with the pair trading around 17,910 during Friday’s Asian session. The Indonesian Rupiah is firming as the US Dollar (USD) softens alongside reduced expectations for additional Federal Reserve rate hikes. According to the CME FedWatch Tool, traders are assigning nearly a 28% likelihood to a policy rate increase in October.

Fed Outlook, Yields, and US Labor Data in Focus

Despite the recent pullback in the Dollar, sentiment could shift again if inflation concerns intensify, particularly amid elevated energy prices and the possibility of another Fed move in December. Benchmark US Treasury yields remain volatile, with 10-year and 30-year yields hovering near 5.25% and 5.62%, respectively, after easing from multi-decade peaks as fiscal and political tensions in France boosted demand for safe-haven assets.

Even after their recent retreat, US government bond yields are still around their highest marks since 2002. Expectations of further Federal Reserve tightening, combined with evidence of resilience in the US economy and unease over the country’s long-term fiscal and debt profile, are helping to keep yields elevated.

Market participants are closely tracking incoming US data to refine their monetary policy expectations, with particular attention on the forthcoming Nonfarm Payrolls report. Economists anticipate a gain of 90,000 jobs, down from the previous increase of 162,000, while the Unemployment Rate is projected to remain at 4.1%.

Bank Indonesia Flags External Pressures on the Rupiah

On the domestic side, Bank Indonesia (BI) Governor Destry Damayanti indicated that recent weakness in the Rupiah had been shaped primarily by external developments, including shifts in global capital flows and vulnerabilities in Indonesia’s external-sector fundamentals. She noted that headline inflation in September accelerated to 3.28%, the highest in three months, as food prices remained under pressure, partly linked to El Niño-related effects.

Inflation Outlook: Food Prices and El Niño in the Spotlight

Analysts at ING’s Asia research team see scope for Indonesia’s overall inflation to rise further over the coming months. They forecast that “Indonesia’s CPI inflation [will] accelerate to 3.3% YoY, as El Niño drives further increases in food prices.” The team emphasizes that “rising rice prices should remain a key driver,” and warns that “spillovers from higher food costs are also likely to add to core inflation,” signaling broader, underlying price pressures building in the economy.

Understanding Inflation and Its Market Implications

Inflation represents the increase in the cost of a representative basket of goods and services. Headline inflation is typically reported as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation strips out more volatile components, such as food and fuel, which can be heavily influenced by geopolitical developments and seasonal patterns. Core inflation is the measure that economists monitor most closely and is the primary focus of central banks, which generally aim to keep inflation near 2%.

The Consumer Price Index (CPI) tracks how the prices of a specified basket of goods and services evolve over time and is also reported on MoM and YoY bases. Core CPI, which excludes food and fuel, is watched particularly carefully by central banks. When Core CPI moves above 2%, it commonly leads to higher policy rates, while readings below 2% tend to result in lower rates. Because higher interest rates usually support a currency by attracting capital inflows, stronger inflation often coincides with a firmer currency, and the opposite is typically seen when inflation declines.

In foreign exchange markets, what can appear counter-intuitive is that elevated inflation in a country can support its currency, while subdued inflation can weigh on it. The reason is that central banks often respond to higher inflation by raising interest rates, which can draw in foreign investors in search of higher yields.

Gold’s relationship with inflation has also evolved. In the past, investors frequently turned to Gold during periods of high inflation because it could hold its value. While Gold still retains safe-haven appeal during episodes of severe market stress, the dynamics have shifted. When inflation is high and central banks lift rates to counter it, the opportunity cost of holding non-yielding Gold versus interest-bearing assets or cash deposits rises, which is generally negative for Gold. Conversely, when inflation and interest rates fall, Gold can become relatively more attractive as an investment alternative.