One of the differences between Donald Trump\'s presidency and that of previous presidents is his use of mass media to express his disappointment with the US Federal Reserve (Fed) governor’s policy on the central bank’s benchmark interest rate. Trump has even threatened to dismiss him.
This was first disclosed in December 2018, when the Fed raised its interest rates as the US economy began to show signs of a possible recession in the next year or two. These signs emerged on 4 Dec. 2018 with the first occurrence of an inverted yield curve (short-term yields on US Government bonds are higher than long-term yields).
The threat of dismissal was not repeated because the US economy was still growing, showing signs of expansion with controlled inflation. The symptom of the inverted yield curve also weakened in April 2019. In the first quarter of 2019, the US economy grew 3.1 percent year-on-year (yoy), up from 2.2 percent in the previous quarter.
The inverted yield curve indicator started blinking again in May 2019. This time, it was accompanied by several other indications, such as a decline in interstate freight shipping by trucks. Several large companies, such as Nike, Apple and Caterpillar, have been warning about their weakening businesses since May 2019, marked by declining sales and profits.
The businesses’ weakening has been attributed to the US-China trade war. Trump, who will run for reelection in 2020, sensed this sign and began to again raise the issue of the Fed’s need to reduce interest rates. The Fed was the target, and the threat to dismiss the Fed Governor was again heard.
Phillips Curve
Regardless of whether the reason is Trump\'s pressure or a question of timing, the Fed has been more accommodating of the idea to lower its interest rates. Fed Governor Jerome Powell recently said that the Phillips Curve concept was now dead because of the very weak relationship between the unemployment rate and inflation. As a result, it is very possible that the Fed will reduce interest rates to maintain an employment level that is as close to full employment as possible without worrying over increasing inflation rate.
This statement was made ahead of the Fed\'s Board of Governors meeting at the end of July, and sent a strong signal that the US benchmark interest rate would be lowered (soft landing) to mitigate the upcoming US recession.
It seems that foreign investors in the US welcomed the signal by allocating more portfolios to emerging markets. For Indonesia, the stock market line has been clear since April.
By the end of June, in line with the Constitutional Court’s relief decision, almost US$5 billion in capital has accumulated on the stock market to have a positive impact on the JCI and the rupiah. The trade balance also showed improvement, albeit with a narrow surplus. In May, the balance sheet recorded a surplus of US$210 million. The June balance sheet also recorded a surplus. The two consecutive months of surplus, although not yet ideal, provides a glimmer of light, increasing the positive indicators of the Indonesian economy.
Anticipation
The abovementioned positive factors, plus low inflation (0.68 percent in May and 0.55 percent in June), have prompted Bank Indonesia (BI) to take the opportunity to take action ahead of the Fed meeting at the end of July, lowering its benchmark interest rate by 25 basis points to 5.75 percent.
The consumer side shows positive expectations (BI survey). Consumer confidence in durable goods (especially non-vehicle electronics) increased again to 116.5 in June 2019 from 115.6 the previous month.
The lower interest rates will help the automotive sector, and will have a large multiplier effect on the property sector. Until of 2019, the production remained sluggish in the first quarter as a residual effect of the 2019 presidential election. The Business Tendency Index (ITB) was 104.71 in the fourth quarter of 2018, compared to 102.1 the previous quarter.
Even though there will be a pause in lowering loan interest rates, the lower benchmark rate is expected to encourage production. In line with the improved ITB, which was 106.44 in the second quarter, lowering the interest rates is expected to boost growth in real investment to 8 percent per year and even more in the third and fourth quartes.
President Joko Widodo\'s speech on 14 July 2019 has provided a solid guideline on how to take advantage of the domestic economy, the purchasing power of the middle-class and Indonesian diaspora, and education and bureaucratic reform as a major countercyclical strategy against the global economy, which is currently slowing.
The speech also laid out the foundation for strengthening Indonesia’s competitiveness for entering the global supply chain. BI’s synergetic rate policy that anticipates the Fed provides added driving force like, afterburners on aircraft engines.
Ari Kuncoro, Professor and Dean, Economics and Business School, University of Indonesia