November 9th Financial News

Daily News

Summary:

Minutes show divisions within Bank of Canada; Fed's Jefferson says the Fed must sometimes act despite uncertain outlook; the earnings season is coming to an end...

[Quick Facts]

1. Minutes show divisions within the Bank of Canada.

2. Fed's Cook: Geopolitical tensions could change U.S. economic outlook.

3. Fed's Jefferson: Fed must sometimes act despite uncertain outlook.

4. S&P 500 gains for an 8th day, the longest win streak in 2 years.

5. Earnings season is coming to an end.

[News Details]

Minutes show divisions within the Bank of Canada

The Bank of Canada (BOC) meeting minutes released yesterday showed that officials faced the same problems in October as they did in September, that was, they remained perplexed by the persistent core inflationary pressures. Some Board members argued that the policy rate may need to be raised further, showing certain disagreement among policymakers. It's unclear what's behind the members' views, but the minutes suggested that some members could start pushing for further policy tightening if the economy and inflation don't match.

Fed's Cook: Geopolitical tensions could change U.S. economic outlook

In a speech on Wednesday, Nov. 8, Fed Governor Lisa Cook said that worsening geopolitical tensions, including in Russia and the Middle East, could trigger broad negative spillovers to global markets. Escalating conflicts could drag down economic activity and trade, raise financing and production costs, and create more persistent supply chain challenges and inflationary pressures that could ultimately alter the path of the U.S. economy.

Geopolitical tensions, in particular, could destabilize commodity markets and the credit system in the current environment of higher interest rates. We are watching and need to be vigilant about this.

However, she did not elaborate on her views on the U.S. economic outlook or comment on Fed policy rates, nor did she state how likely she thought these potential risks were to come true.

Fed's Jefferson: Fed must sometimes act despite uncertain outlook

Despite the high uncertainty surrounding the economic outlook, policymakers will need to respond forcefully if inflation expectations begin to heat up, said Fed Vice Chair Philip Jefferson said on Nov. 8. As Fed Chair Jerome Powell mentioned in his 2018 speech, there are two particularly important cases in which doing too little when there is high uncertainty comes with higher costs than doing too much.

The first case is when attempting to avoid severely adverse events such as a financial crisis. In this situation, words like "we will do whatever it takes" will likely be more effective than "we will take cautious steps." The second case is when inflation expectations threaten to become unanchored. If expectations were to begin to drift, the reality or expectation of a weak monetary policy response would exacerbate the problem.

S&P 500 gains for an 8th day, the longest win streak in 2 years

The S&P 500 gained 0.1%, matching an eight-day string of gains it notched in November 2021. The Nasdaq Composite Index edged up 0.08%. The Dow Jones Industrial Average fell by 40.33 points, or 0.12%, ending its best streak of gains since July.

While upcoming inflation and economic data could weigh on the stock market's gains, the data continues to suggest the economy is slowing, but not falling off a cliff. Cautious remarks from several hawkish Fed members dampened optimism that interest rates have peaked, weakening the stock market's rally.

Earnings season is coming to an end

Out of the approximately 88% of companies in the S&P 500 have reported results, more than 88% have surpassed earnings estimates. However, only 62% have beaten revenue expectations. Some companies offer cautious outlooks.

Rivian shares fell by 2.4% even after reporting better-than-expected results, while Robinhood slumped by 14.3% in a single day after announcing a sharp drop in trading volume. Warner Bros. shares plummeted by 19% after posting a wider-than-expected loss. It was its worst day since March 2021. Roblox rose by 11.8% on the back of its strong results.

Disney reported better-than-expected quarterly earnings after the close, thanks in part to earnings from ESPN+ and continued theme park growth, but a decline in advertising revenue hurt total revenue. Shares of the company were up more than 4% after Wednesday's close. Semiconductor technology firm Arm reported its first earnings on Wednesday after being listed, with sales beating Wall Street's expectations and showing that the company's lucrative licensing business has doubled in the past year. However, Arm's shares fell more than 7% in after-hours trading as the company's revenue estimates came in below expectations.

The recent market moves further confirm the trend throughout the quarterly earnings season: In the current market environment, stocks are falling more than usual if they fail to meet Wall Street's earnings estimates. Stocks of S&P 500 companies that missed earnings-per-share estimates for the third quarter fell by an average of 5.2% over the next two days, according to data released on Tuesday by FactSet. That's more than the average for the past five years.

[Focus of the Day]

UTC+8 16:10 European Central Bank Chief Economist Philip Lane Speaks

UTC+8 16:30 Bank of England Chief Economist Huw Pill Speaks

UTC+8 16:35 Bank of Japan Governor Kazuo Ueda Gives an Interview with Financial Times

UTC+8 22:30 2024 FOMC Voting Members Raphael Bostic and Thomas Barkin Speak

UTC+8 00:00 Next Day: Richmond Fed President Thomas Barkin Speaks

UTC+8 01:30 Next Day: European Central Bank President Christine Lagarde Speaks

UTC+8 03:00 Next Day: Fed Chair Jerome Powell Speaks at an Expert Panel Organized by the IMF

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Commodity

Sinking yields unable to boost gold On paper, last week had all the elements to be incredibly bullish for gold. Yields on US government bonds came crashing down, which in turn inflicted heavy damage on the US dollar. Both of these developments are normally positive for gold prices, and yet the precious metal was unable to advance. Yields are essentially the price of money, so they can be considered interest rates that are determined by market forces. Gold doesn't pay any interest to hold, so when yields or interest rates fall, the metal becomes more attractive by comparison. In similar logic, because gold is denominated in US dollars, a weaker dollar is also beneficial for gold as it makes it cheaper to buy for foreign investors.

Is the Geopolitical Rally in Gold Exhausted?_1

Hence, it is strange that gold could not rally even with such a favorable setup in bond and FX markets, and instead moved lower. It appears these positive effects were overpowered by something even stronger, and the answer might boil down to geopolitics. No escalation in the Middle East, After Israel was attacked in early October, gold prices rallied more than 10% in the next few weeks as safe-haven demand went into overdrive. Investors were running scared about an escalation in the conflict that could spread to the entire region and drag Iran into the war. Gold is considered the ultimate hedge against such geopolitical risks. But the conflict never escalated. As horrific as the situation is, it hasn't spiraled out of control to engulf the whole Middle East. And since the threat never materialized, it appears that speculators have started to exit some of their long positions in gold that were meant to protect them from a conflagration in the war.

Is the Geopolitical Rally in Gold Exhausted?_2

Therefore, fading demand for safe haven assets might be behind gold's relative weakness. The recent decline in oil prices argues the same point. Oil has also served as a barometer for geopolitical stress over the past month amid concerns of potential disruptions to crude shipments. Hence, the selloff in oil reinforces the view that the 'war premium' is being priced out. Central bank purchases Beyond the flare up in Israel, another important factor that has supported gold prices this year have been direct purchases by central banks, led by China. Beijing is essentially trying to diversify its reserves, shifting away from dollars or euros and towards gold. This trend started after Ukraine was invaded. The subsequent sanctions against Russia saw around half of the nation's reserve assets getting frozen. Naturally, China is concerned about suffering the same fate should diplomatic relations with the West deteriorate. As such, Beijing is buying hard assets like gold, which cannot be frozen so easily.

Is the Geopolitical Rally in Gold Exhausted?_3

Considering that the 'new Cold War' between the US and China continues to heat up, spreading to technology sanctions lately with America banning the export of advanced semiconductor chips to China, this strategic shift towards gold could be a multi-year process. What would it take for new record highs? All told, despite the volatility, gold prices have been trapped in a wide sideways range for three years now, trading between the lower bound of $1,680 and the record high of $2,072. A significant catalyst will probably be required for this range to be broken. A return of recession fears might be the most powerful trigger for a sustainable rally in gold. If market participants panic about the economic outlook, fueling bets of Fed rate cuts, that could push yields sharply lower and by extension breathe life into gold. This might be a story for next year, as the global economic data pulse has started to weaken.

Is the Geopolitical Rally in Gold Exhausted?_4

A softer US dollar can also do the trick. Gold prices are already at record levels when denominated in other currencies except for the dollar, as shown on the chart above. Hence, a persistent decline in the dollar could be another blessing for gold. That said, this scenario seems unlikely considering that most economies are in worse shape than the United States. To conclude, the performance of gold will be decided by a combination of geopolitical tensions, the path of interest rates, direct central bank purchases, and how the economic landscape evolves. In this sense, the near-term outlook seems somewhat negative, amid fading geopolitical demand. However, the tides could turn next year as the world economy loses steam and some regions go into recession, giving gold the firepower it needs for another rally towards record highs.

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SAXO

Economic

A remarkable cycle so far

The consensus call among economists in late 2022 was that the global economy would enter a recession in 2023, and we also quiet negative going into the year. The US yield curve inversion was also reflecting this view and the brief banking crisis in March with the meltdown in Silicon Valley bank supported the view. Two factors played a key role in offsetting the pain from rising interest rates. The $1trn fiscal expansion by the Biden Administration and the investment boom related to generative AI and reshoring of semiconductor manufacturing capacity through the US CHIPS Act underpinned growth.

Economic activity in the US is roughly around trend growth since the 1980 (the zero value on the first chart below) which is the strongest economic activity recorded in the US since 1978 after 23 months of the US Leading Index peaking (it peaked in December 2021). Only the Great Financial Crisis path was roughly as strong at this point in the cycle. There are two main paths from here.

1. US economic activity begins to significantly deteriorate with the US economy entering a recession before the second half of 2024. A side effect might be a debt crisis or liquidity shock as a causal effect from the steepest policy rate trajectory since WWII.

2. The US economy and consumer absorbs the interest rate shock with the labour market remaining strong enough to support real wage growth and a soft landing making it the first slowdown of this scale that does not end up in a recession. A side effect of this scenario is inflation dynamics will strengthen and push US long-end bond yields higher.

The fiscal deficit trajectory is going to be important and already now there are signs that the US fiscal cycle is turning as the US government is forced to rein in spending. In this case the US economy will experience a significant negative fiscal impulse forcing the economy to slow unless it is offset by private investment boom.

One thing is for sure. If history is any guidance, and we dare point weight on six independent periods in which the US Leading Index peaked (ahead of recession), then the next 6-9 months are going to be some of the most fascinating for financial markets in a long time. Is The Economic Pain Coming After Great Delay?_1

Is The Economic Pain Coming After Great Delay?_1

Will generative AI and automation make the 2020s like the 1960s?

Longer term the most interesting debate and economic observation will be that of 1) potential negative impact from a debt crisis or unsustainable government debt dynamics spurred by the higher interest rates, and 2) productivity boost from generative AI and automation technologies. In the now famous McKinsey report on generative AI and its potential productivity boost, it is estimated that generative AI in combination with other automation technologies could boost productivity growth by 0.2 to 3.3 percentage points by 2040. If that becomes a reality then it is a new paradigm for interest rates.

The previous productivity boom periods in the US were the 1950-1969 and 1995-2004 periods were estimated annualized productivity growth was around 2.5 to 2.7 percentage points. In the post GFC period from 2010-2018 the annualized productivity growth was only 0.9 percentage points leading to great debate about low productivity growth. The period 2019-2023 has delivered annualized productivity growth of 1.9 percentage points with the recent reading at 4.7 percentage points which is the highest reading, excluding the data points during the pandemic rebound in Q2 2020, in more than 13 years.

Imagine an economy that delivers a 1950-60s style productivity growth of 2.7 percentage points with 0.8 percentage points annualized increase in the labour force, then the real GDP growth could be around 3.5 percentage points. If we then add 3 percentage points of annualized inflation due to reshoring, green transformation, and disruptive weather (price of food production) then we are suddenly talking about nominal GDP growth above 6.5% annualized. If this longer term scenario becomes a reality then US long-end bond yields will not return to the low levels observed in the post GFC period.

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Justin

Economic

The foundation of the forecast is the finding that AI could ultimately automate around 25% of labor tasks in advanced economies and 10-20% of work in emerging economies, Goldman Sachs economists Joseph Briggs and Devesh Kodnani write in the team’s report.

They estimate a growth boost to GDP from AI of 0.4 percentage points in the US, 0.3 percentage points on average in other DMs, and 0.2 percentage points on average in advanced EMs by 2034. In other emerging markets, Goldman Sachs Research forecasts a smaller boost from AI given adoption will probably take longer and AI exposure will likely be lower.

“We expect this automation to drive labor cost savings and free up workers’ time, some of which will likely be allocated to new tasks,” Briggs and Kodnani write. The ultimate size of those effects will depend on how capable AI actually becomes and how it’s implemented.

How much can AI improve productivity?

In the baseline scenario, the Goldman Sachs Research economists estimate AI could increase US productivity growth by 1.5 percentage points annually assuming widespread adoption over a 10-year period. They expect similar effects in other major developed markets, and a somewhat smaller impact of 0.7-1.3 percentage points in most emerging economies given their higher share of employment in sectors with low AI exposure like agriculture and construction.

Taken at face value, those kinds of productivity gains would suggest a substantial jump in GDP growth around the globe. Assuming workers aren’t permanently replaced by automation and there’s capital to support the increase in productivity, the increase in productivity could boost long-run worldwide GDP by as much as 15%. But Briggs and Kodnani think the net effect will be somewhat lower than that for two key reasons.

First, our economists already include technological innovation in their economic forecasts. Simply adding their estimates for the boost in productivity from AI to the current trend would likely result in some double counting. They note that information and communication technology (ICT) investment has already been the main driver of productivity growth in major economies over the last 20-30 years.

And second, the underlying productivity growth has been slowing. Academic research suggests that growth in total factor productivity (calculated by dividing real output by the combination of labor and capital inputs) tends to slow over time as countries develop, except during rare “regime shifts” such as those triggered by the first and second industrial revolutions.

Predictions of AI superintelligence seem premature

Is generative AI different? Some observers have argued that it could be a paradigm-shifting technology that ushers in a new regime for productivity growth. Equity analysts in Goldman Sachs Research have identified sectors where they think this could happen, including in healthcare and drug discovery, cybersecurity, design, and software development. Some have gone a step further and view recent advancements in AI as a meaningful step towards a “superintelligence” that is able to process information, formulate views, and innovate beyond the capability of humans.

For now, the more extreme predictions appear “very premature, especially given the well-documented limitations of current AI models,” Briggs and Kodnani write. “We therefore maintain our view that for the foreseeable future, generative AI will mostly drive efficiency gains by automating less difficult but time-consuming tasks, thereby empowering workers to engage in more productive activities.”

In the meantime, much will depend on the adoption timeline. Historically, productivity booms driven by prior milestone technologies — such as the electric motor and personal computer — have lagged the initial innovation by more than a decade. These innovations only began to show up in macroeconomic data once roughly half of affected businesses had adopted the technology.

“We have been relatively cautious on the AI adoption timeline,” Briggs and Kodnani say. “While a rapid acceleration in AI-related investment is ongoing for leading technology and professional services firms which are developing and pioneering the use of AI, the effects on productivity that we have estimated will require the implementation of AI across a broader set of industries and job functions.”

AI’s effects on GDP will take time to emerge

Surveys of businesses and executives indicate that they generally anticipate a small impact from AI on activity and hiring needs in the next 1-3 years but a much larger impact in the next 3-10 years. Likewise, Goldman Sachs Research expects broad-based adoption to accelerate in the US beginning in the second half of this decade. The adoption timeline may be even more drawn out elsewhere, as the US and other advanced economies have historically led in the adoption of milestone technologies.

Taken together, our economists’ model indicates AI will probably have a positive impact on GDP over the next decade — but it will take a few years to show up in the numbers. Goldman Sachs Research is leaving its forecasts unchanged until at least 2027 for the US and 2028 for other economies. How the timeline for adoption plays out, the amount of ICT investment that’s displaced by AI spending, the extent of AI’s emerging capabilities, as well as potential regulatory barriers, will all influence how and to what extent these economic gains are realized.

“Our estimates reflect a balanced consideration of these risks, and provide a template for analyzing the longer-run effects of AI on the macroeconomy,” Briggs and Kodnani write. “In our view, the development of capable AI is likely to be among the most consequential macroeconomic stories of the 21st century, with important implications for relative economic performance, financial market returns, and longer-run interest rates.”

Source:Goldman Sachs

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Cohen

Stocks

Economic

Every investor wishes they had a crystal ball. Anyone who did would have piled into Amazon at the start of the millennium, bet the house on Apple shares, and shorted banking stocks moments before the financial crisis struck in 2007.

They'd have bought shares in Zoom, Peloton and Netflix before the pandemic and sold them as the lockdown ended, and made an overnight fortune playing GameStop, AMC Entertainment and all those other mind-bending meme stocks.

Investing would be all upside, and no downside, if only we knew what was coming round the corner.

Sadly, we don't. There's no crystal ball. Second-guessing market movements is next to impossible, nobody knows what's coming next. We remain at the mercy of events.

That doesn't stop people from trying, though. You can always find one analyst or another calling the next bull run or stock market crash, even if they get it wrong 99 times out of 100.

The big irony of investment predictions is that short-term movements are impossible to second-guess, while longer term trends are a bit more predictable.

Few will have predicted the wild swings we have seen this millennium, as the dot-com crash, 9/11 terror attacks, global financial crisis, pandemic and energy shock left investors reeling. Or foreseen the sheer scale of the decade-long US tech stock rally.

Yet, those who assumed that in the longer run shares would still beat every other asset class, as they have done for more than a century, will largely have been proven right.

Similarly, we can assume that bonds will deliver a lower return but with less risk, and splitting the two asset classes in a 60/40 equity-bond portfolio gives investors the best of both worlds – with the notable exception of 2022, when both crashed at the same time.

This knowledge emboldens the likes of JP Morgan Asset Management to publish its annual Long-Term Capital Market Assumptions, which provides a 10 to 15-year outlook for risks and returns across major asset classes.

Its 28th edition, just published, aims to provide "actionable insights as investors look to build smarter portfolios in the midst of a transition from disinflation to reflation, and from policy accommodation to higher costs of capital".

It aims to provide, if not a crystal ball, then at the very least a "road map" to steer through unpredictable markets.

So, what's the direction in 2024 and beyond?

The good news is that the forecast annual return for a US dollar-dominated 60/40 stock-bond portfolio over the next 10 to 15 years is an attractive 7 per cent per year.

Investors who add a 25 per cent allocation to alternative assets have "clear opportunities" to boost this to around 7.6 per cent, it says.

Investors will be delighted to hear that the "long-term growth outlook has risen slightly", as automation and artificial intelligence boost productivity, while the energy transition and new technologies deliver thrilling new investment opportunities.

While these trends will drive developed market growth, the report's emerging market forecasts have "dipped slightly due to lower trend growth in China".

JP Morgan head of global multi-asset strategy John Bilton says the world is entering a period of significant economic transition in the wake of the global pandemic and heightened geopolitical tensions, and this will have far-reaching implications for investors.

"We are now moving away from an environment with persistent disinflation, ultra-easy monetary policy and fiscal restraint," Mr. Bilton says.

This transition requires investors to build "robust portfolios", which should include reducing cash exposure to harvest better returns and broaden international exposure to enhance returns and diversification, he adds.

JP Morgan's LTCMA lands just as investors get their appetite for risk back after the US Federal Reserve, European Central Bank and Bank of England all froze interest rates again, suggesting the rate hike cycle may now have peaked.

While central banks warn that rates could still climb higher – and the Fed may even mean it – investors have rediscovered their appetite for risk as they anticipate the end of rate hikes, says Kyle Rodda, senior market analyst at Capital.com.

"Risk appetite remains strong after this week's positive developments on the monetary front, despite mixed corporate results and lingering geopolitical worries in the Middle East," he adds.

Lindsay James, investment strategist at Quilter Investors, says peak interest rates should be good news for investors and next year's anticipated rate cuts would be even better, "as they can often bring about very strong returns".

"While markets may not be shooting the lights out, remaining invested over this period is going to be crucial," she adds.

Chris Beauchamp, chief market analyst at online trading platform IG, says last week's stock market rally arrived "almost on cue in seasonality terms", as the final weeks of the year tend to be best for shares.

However, he also warns that hopes of peak rates have been dashed before and investors "need to resist the temptation to charge back into stocks too quickly".

Yves Bonzon, group chief investment officer at Swiss bank Julius Baer, reckons concerns that the Israel-Gaza conflict will spiral out of control and send oil prices soaring have been overdone. Instead, he is looking forward to a year-end rally.

He says the US stock market has been the big winner of the past decade and is likely to dominate global capital markets in 2024 and beyond.

"Regardless of relative valuations, there is a reason why US assets continue to outperform non-US assets for an extended period of time. In light of the new geopolitical reality, there is simply no sizeable alternative to US dollar capital markets for Western investors," adds Mr. Bonzon.

He also suggests we are on the cusp of an "innovation super cycle", which would allow for significant value creation among market leaders.

"Historically, the Nasdaq has been at the forefront of creating such value during these super cycles. We would selectively consider disruptive innovators in other domiciles, too," says Mr. Bonzon.

The US may be mired in debt and facing a potential recession. But, as history shows, no market can touch it and that is likely to remain the case for the next 10 to 15 years, too.

Shares have had a bumpy ride, but is there really any serious alternative?

Just remember to diversify. Now may be a good time to also buy a few government bonds as yields peak.

Build a balanced portfolio and hold for the long term. No crystal ball required.

Source: The National News

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Damon

Economic

Forex

The dollar's recent weakness will linger for the rest of the year, according to a majority of FX strategists in a Reuters poll, who also said economic data will be the primary influencer of major currencies for the rest of 2023.

Renewed expectations the Fed is done with its rate hikes have put the dollar at a disadvantage, with the currency losing almost 2.0% from last month's peak, leaving the dollar index up around 2% for the year.

Suggesting the current dollar weakening trend has further to go, a near two-thirds majority of analysts, 28 of 45, who answered a separate question said the dollar is likely to trade lower than current levels against major currencies by year-end.

They also expect it to slip against the euro and other G10 currencies over the next 12 months, a position analysts have held all year but have been proven wrong each time. Some are sounding more confident this time they will be right.

"The dollar and U.S. yields have had a strong bullish trend over the (past) two to three months ... but it looks like we've reached a point where yields and the dollar have peaked out," said Lee Hardman, senior currency analyst at MUFG.

"It's going to be harder for yields to hit fresh highs this year because markets are now more confident that the Fed is done hiking, speculation has already started to intensify again that next year we could see a policy reversal from the Fed with speculation building over more aggressive Fed rate cuts next year."

When asked what will be the primary influencer of major currencies for the rest of the year, a slim majority of analysts, 26 of 49, said economic data. Another 20 said interest rate differentials, and three said safe-haven demand.

Recent employment data suggest cracks are finally appearing in the world's largest economy's surprising resilience to rate hikes over the past year and a half. But the U.S. economy is still performing better than all of its peers.

The latest data from the Commodity Futures Trading Commission showed currency speculators were still overwhelmingly net-long on the U.S dollar, suggesting there was still plenty of support for the greenback.

"At the moment, we're still tactically long dollar and we think this will have further to run into year-end, primarily against currencies where they continue to show weak fundamentals. EUR/USD would be the primary case of that," said Simon Harvey, head of FX analysis at Monex Europe.

The euro zone economy shrank 0.1% last quarter and is expected to flat-line in this one, barely skirting a recession. The euro, after clawing back all of its losses for the year, is predicted to gain around 4.0% over the coming 12-months.

Median predictions from 72 foreign exchange strategists showed the common currency trading at $1.07, $1.08 and $1.11 in the next three, six and 12 months. Those estimates are broadly unchanged from an October survey.

The Japanese yen, the worst-performing major currency for the year, is expected to remain under pressure in the near-term.

Asked what is the weakest level the yen will trade against the dollar by year-end, 20 analysts who answered a separate question returned a median of 152/dollar.

However the currency, which has lost about a third of its value since 2021 including 13% this year alone, is expected to recoup most of its 2023 losses over the next 12-months.

The yen is expected to gain over 10% to change hands at 136/dollar in a year, the poll showed.

Sterling, already up around 1.5% in 2023, is forecast to gain 3.5% to $1.27 in a year.

Emerging market currencies are expected to take well into next year to post noticeable gains against a retreating U.S. dollar.

Source: Reuters

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Thomas

Bond

Economic

Foreign investors are setting the bar high when it comes to buying Indonesian bonds, as debt from other regions starts to look more attractive.

Yields on Indonesia's benchmark sovereign bonds need to rise to 7.5%, which is around 80 basis points higher than where they are now, said JPMorgan Asset Management and First Sentier Investors. Brandywine Global Investment said yields may have to be at least 300 basis points above their U.S. equivalent, compared with the current spread of around 200 basis points.

That shows investor sentiment towards Indonesian bonds, which were heavily sought after by emerging-market investors before Covid, is worsening due to a weak currency and narrow rate differential with the U.S.. Some funds are now gravitating towards bond markets, including those in Latin America (LatAm) that are benefiting from an easy monetary policy and benign inflation.

Investors can buy Brazilian bonds for higher yields compared to the likes of Indonesia as long as they can weather higher fiscal and political uncertainties, said Desmond Soon, a portfolio manager at Western Asset Management Co.

"LatAm countries are sort of high-octane, high-yield, and Asia is more mezzanine," Singapore-based Soon said, adding that he is also rotating some of his fund's exposure out of Indonesia in favour of peers like India.

Indonesian Bonds No Longer Darlings in Emerging Markets_1

Foreign investor apathy is dealing a blow to Bank Indonesia's (BI) efforts to stabilise its currency after outflows of about US$2.5 billion (RM11.68 billion) from rupiah debt in the last three months, the biggest in a year. Global funds now hold less than 15% of outstanding Indonesian government bonds from around 40% before the Covid, according to data compiled by Bloomberg.

The central bank issued new securities to allow short-term yields to rise, in hopes of attracting more inflows, while also buying some debt to build market confidence, but to no avail.

"BI has recently come back to start buying up some bonds because they know that the market is unravelling," Carol Lye, a portfolio manager at Brandywine Global Investment Management, said last month. "On a real yield spectrum, Indonesia does well on its own — but it's when you compare it to the rest of the markets that it doesn't shine as bright," said Lye who hadn't held Indonesian sovereign bonds for a year.

Increased sensitivity of Indonesian bonds to Treasuries is also capping rupiah bond yields. The 10-year U.S. yield fell 35 basis points in November after the U.S. Federal Reserve signalled it's done with hiking rates. Indonesian yields of the same tenor also dropped by about the same amount to around 6.7%.

Indonesian Bonds No Longer Darlings in Emerging Markets_2

Investors are now watching if BI will tighten its policy further after it surprised markets with an interest-rate hike in October and kept the door open for more. Indonesia is in a far better position than some of its peers in Asia when it comes to managing inflation, but it falls short in comparison with LatAm.

Price gains have been within BI's target since May, while the Philippines faces the risk of missing its price goal for a third straight year in 2024. Price pressures likely eased in Mexico, Chile and Colombia last month, while the Peruvian central bank is set to cut its benchmark rate for a third consecutive meeting.

Indonesia will need to continue hiking rates in this part of the cycle as U.S. rates stay high, said George Boubouras, the head of research at hedge fund K2 Asset Management in Melbourne. "To attract foreign capital, you just need to hike rates even more to make sure there's a good spread to U.S. Treasuries," he said.

Tide turning?

Still, some investors such as JPMorgan Asset Management are turning more constructive on some Indonesian debt, even as they caution that yields need to climb further.

The bank bought rupiah debt with a maturity of up to two years as it sees carry-and-roll in those tenors compensating for any U.S. Treasury volatility. The fund had taken profits on an earlier position in long-dated debt mid-year as the bonds rallied through 6.5%, he said.

First Sentier Investors has also bought two-year notes, and expects foreign investors to eventually return due to the nation's fundamentals, said Nigel Foo, the head of Asian fixed income. "Should these foreign investors come back, they will come back in a very big way," he said.