Asia’s Carry-Trade Darling Haunted by Politics as Fed Looms

Indonesia’s rupiah may reverse gains that made it emerging Asia’s top performer in 2016 as some of the currency’s key supports risk turning into Achilles heels.

President Joko Widodo’s economic reforms have underpinned the rupiah’s advance, as have the highest Asian bond yields after Pakistan, which make its debt a favorite among foreign investors. This year, politics could become a drag, with the Widodo-backed governor of Jakarta under fire from Islamic groups before next month’s city election run-off, while U.S. tightening risks reducing that much-loved yield advantage. And then there’s Donald Trump.

Up 1.1 percent to 13,325 per dollar this year, the rupiah may slump 1.7 percent by the end of June, the median of analysts’ estimates compiled by Bloomberg shows.

“The main risk to the rupiah is from the large foreign bondholding amid rising U.S. rates and overweight positioning by real-money investors,” said Dushyant Padmanabhan, a currency strategist at Nomura Holdings Inc. in Singapore, who sees the currency falling 2 percent by June 30. “It’s also susceptible to broader risk aversion from protectionist U.S. policy, geopolitical risks or a turn in sentiment.”

Speculation Indonesia is next in line for a credit-rating upgrade has also buoyed the rupiah and Indonesian assets, with more than $4 billion flowing into the country’s bonds and stocks this year.

But that investment could be a double-edged sword, with foreign ownership of Indonesian sovereign bonds now at 38 percent, the highest in the region. That raises the prospect of large capital outflows and an uptick in volatility should the Federal…

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