The Driving Forces of Historically Low Yields in Indonesia
The 10 year Indo GB yields has declined to below its long term average. In this report we tried to understand the driving force behind this phenomenon.
Here we lied a fundamental approach to understand why low yields of Indo GB is justified by employing a regression analysis considering multiple factors such U.S. treasury yield, 5 year CDS, USD/IDR, foreign ownership on government securities, policy rate and inflation.
Even with the historically low yields, Indo GB still offers attractive valuation in terms of real yield. Central bank’s intervention through expansionary monetary policy and government debt monetization, as well as banks risk averse behavior drove government bond yields to decline despite a recorded a net foreign outflow since market turmoil in March-April last year.
In addition, lower local currency denominated government bond in 2021 was also attributable to lower rupiah volatility. Despite widening fiscal deficit and rising indebtedness, yields of rupiah denominated government bonds are stably below its 10 year average.
Our econometric model has shown that rupiah denominated government bonds positively responded to U.S. treasury, 5 year CDS, USD/IDR, foreign ownership, policy rate and inflation shocks based on Impulse Response Function (IRF). However long term declines in this fixed income assets can be briefly justified by a lower risk premium and benign and manageable inflationary pressure as Variance Decomposition (VD) showed. These two factors contribution gradually increase as time as time goes on to the yield.
Corporate Bonds Market Behavior During Low Yields of Government Bond
We observed that the downtrend in government bond yield also became a positive catalyst for corporate bond primarily with AAA rating. Spread of AAA-rated corporate bonds to government bonds for 3 & 5 year maturity declined to nearly low of pre-pandemic level. Meanwhile for other ratings, the behavior differ despite spread on 3 & 5 year maturity corporate bonds narrowed across ratings.
Demystifying Stock and Government Bond Correlation
We also tried to quantify the relationship between stocks and government bond in terms of its correlation to understand how these two asset class behave and to assess whether government bond could be an alternative investment during uncertain time (safer asset).
Based on our quantitative method, stocks and government bonds have a long term positive correlation. However the correlation was considered low and the trend is declining. We also observed a negative correlation between these two assets at some point if we take a look more closely on a more high frequency data such as monthly and weekly basis. This results showed that Indo government bond could be a safer asset over stocks particularly in time of market turbulence.
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