The Fed Raises Interest Rates, Strengthening Pressure on Rupiah
The Federal Reserve’s (The Fed) decision to raise interest rates by 25 basis points (bps) to a range of 3.75%-4.00% has the potential to strengthen pressure on the rupiah. This policy not only demonstrates US monetary tightening but also confirms that inflation remains a primary concern for the central bank.
Syafruddin, an economist from Andalas University, stated that the impact of the Fed’s rate hike on the rupiah could be greater than the magnitude of the increase itself. According to him, the risk to the rupiah stems primarily from changes in market expectations regarding the future direction of US monetary policy.
“The impact on the rupiah could actually be much larger than that figure,” he said in a statement on Thursday (17/9).
He noted that 16 out of 18 Fed policymakers anticipate at least one more rate hike before the end of 2026. This condition indicates that US monetary policy could tighten again, despite previous market expectations that rates would remain high for a longer period. The pressure is further complicated by projections that US inflation will reach 3.7% in 2026 and only return to the 2% target by 2029.
Meanwhile, US economic growth is expected to reach 2.3% with an unemployment rate of 4.1%. Syafruddin believes the resilience of the US economy provides the Fed with the room to maintain tight monetary policy. Strong domestic spending, increased productivity, solid capital investment, and a robust labour market all contribute to this.
For emerging economies such as Indonesia, these conditions can serve as a source of external pressure. When US interest rates rise, the yield on dollar-based assets becomes more attractive to global investors, potentially reducing the appeal of assets denominated in rupiah.
Investors will compare the yields of rupiah assets with dollar assets after accounting for exchange rate risks. If the yield differential narrows and the risk of rupiah depreciation increases, investor interest in domestic assets may decline. This pressure is reflected in the US bond market, where the 10-year US Treasury yield stood around 4.96% immediately following the Fed’s decision. Such conditions can increase the attractiveness of dollar assets and encourage investors to increase hedges against exchange rate risks.
“Changes in expectations regarding Fed policy can affect the rupiah before the next rate hike is actually implemented,” said Syafruddin.
Pressure on the rupiah may also arise through a strengthening dollar and increased demand for foreign exchange. Subsequent currency depreciation has the potential to spill over into domestic inflation via imported inflation.
This situation could simultaneously narrow the room for Bank Indonesia (BI) to ease monetary policy. BI previously maintained the BI-Rate at 5.75% in August, considering rupiah stability, inflation, and economic growth.
If external pressure intensifies, BI will face the challenge of balancing exchange rate stability with support for economic growth. Higher interest rates could help maintain the attractiveness of rupiah assets but could potentially dampen domestic economic activity.
Conversely, more aggressive monetary easing could support credit distribution and economic growth but could increase pressure on the exchange rate. Therefore, BI’s policy space will increasingly depend on inflation developments and global financial market conditions. The impact of the Fed’s tightening could also spill over into the state securities (SBN) market, as investors may demand higher yields to compensate for increased exchange rate and interest rate risks.
An increase in SBN yields could subsequently raise government funding costs as well as capital costs for the private sector. This situation has the potential to make credit more expensive and pressure the feasibility of several investment projects with relatively low returns. Nevertheless, Syafluddin believes that a 25 bps increase is not necessarily sufficient to shake the Indonesian economy directly.
The greater risk lies in the possibility of accumulated tightening if the Fed raises interest rates again and US inflation remains above target for an extended period. Therefore, rupiah resilience needs to be strengthened through a combination of policies, ranging from measured foreign exchange intervention and disciplined liquidity management to the provision of attractive financial market instruments.
Strengthening the structural supply of foreign exchange and controlling domestic inflation are also necessary so that rupiah stability does not rely solely on interest rates.
Syafruddin believes Indonesia needs to view the Fed’s rate hike as a change in the global price of capital, rather than just short-term market volatility. As long as the US economy remains strong and inflation remains high, the rupiah could face pressure through foreign exchange markets, SBN, credit, and economic growth.