Turkey sees currency driven inflation beginning to fade as the Lira rallies

A feature of the modern era is the way that we are presented crises but they then fall off the radar screen. An example of this has been Turkey which hit the media heights but has now faded away. Let us update ourselves via the view of Commerzbank on last months central bank meeting.

The Turkish central bank (CBT) left its benchmark interest rate unchanged at today’s meeting. In our view, this was a major policy mistake. CBT commented that it maintains a tight policy stance. But, when the benchmark rate is 24% and inflation is also 24%, how is this stance “tight”? The decision shows that CBT has not morphed into an active inflation-targeting central bank as some government officials have claimed. Rather CBT is simply taking the path of least resistance – since the market is forgiving at the moment, why ruffle political feathers by continuing to hike rates? Given this CB attitude, prepare for more lira volatility down the line.”  ( via FXStreet )

There is a large amount to cover here and let us start with the idea that a major mistake was made. Also that this from the CBRT is wrong.

The tight stance in monetary policy will be maintained decisively until the inflation outlook displays a significant improvement…….Accordingly, the Committee has decided to maintain the tight monetary policy stance and keep the policy rate (one week repo auction rate) constant at 24 percent.

There are many ways of measuring such a concept but an interest-rate of 24% on its own in these times makes you think, especially if we recall that it had been raised by 6.25% at the previous meeting. How many countries even have interest-rates of 6.25% right now? The real issue here to my mind is that Commerzbank  lost perspective with this by looking at inflation at the moment rather than looking ahead. If we take the view of the CBRT from back then the outlook was this.

In this respect, inflation is projected to be 23.5 percent at end-2018, and then fall to 15.2 percent at end-2019 and 9.3 percent at end-2020 before stabilizing around 5 percent in the medium term. Forecasts are based on a monetary policy framework that envisages that the tight monetary policy stance will be maintained for an extended period.

On this basis if we look ahead to when we might expect the interest-rate rise to be fully effective we should start with the end-2019 figure of 15.2%. Against that outlook then a real interest-rate of 9% is for these times eye-wateringly tight. Of course caution is required as central banks are hardly the best forecasters, But I am reminded of the template I set out on the third of May for such a situation.

However some of the moves can make things worse as for example knee-jerk interest-rate rises. Imagine you had a variable-rate mortgage in Buenos Aires! You crunch your domestic economy when the target is the overseas one.

My warning was given when interest-rates in Argentina were 30.25%, by the end of that day they were 3% higher and now the LELIQ rate is 68.1%. Sadly they are living out my warning.

Inflation now

Let us bring this up to date from the Hurriyet Daily News.

Turkish annual inflation surged to 25 percent in October, official data showed on Nov. 5, hitting its highest in 15 years……..Month-on-month, consumer prices jumped 2.67 percent, the Turkish Statistical Institute (TÜİK) data showed, higher than the 2 percent forecast in a Reuters poll. Core inflation surged 24.34 annually. October  inflation was driven by a 12.74 percent month-on-month surge in clothing and shoe prices and a 4.15 percent rise in housing prices, the data showed.

On a yearly basis, the biggest price hike was in furnishing and household equipment in October with 37.92 percent.

Initially Commerzbank may think it was right but this is only a small nudge higher in annual terms as the monthly increase more than halves. We also get a reminder that this is inflation which is essentially exchange-rate driven by the way that the core inflation rate is so similar to the headline. This is joined by which sectors are influenced by imports showing it is a bad time to overhaul your wardrobe or redecorate your home. Speaking of homes there will be central bankers reading this thinking that the rise in house prices is a triumph. The wealth effects! The wealth effects! Back in your box please.

The Turkish Lira

There have been changes here as we look to see what influence it will have on inflation trends. Here is @UmarFarooq_

Turkish is regaining some of its loses, looks set to return to pre-sanction days of August. Went from 6.3 to 5.3 versus dollar in one month. Still a ways to go compared to one year ago, when it was 3.8

Some of the move has been in relation to political changes but from our point of view that only matters if they intervene again. The fact is that a lot of inflationary pressure has faded in the move from the peak of 7.21 against the US Dollar at the height of the crisis to 5.34 as I type this.

So whilst there is still inflationary pressure in the system it has faded quite a lot and if you believe World Economics things are still out of line.

The Turkish Lira has an FX rate of 5.7 but a PPP value of 2.72 against the USD. ( PPP is Purchasing Power Parity)

Of course with inflation so high PPP may need a bit of an update.

Comment

The exchange-rate is the (F)X-Factor here but the inflation trend is now turning although due to base effects the headline may not respond for a couple of months or so. In some ways like so many things these days events have sped up and it has been like a crisis on speed. Here is the latest official trade data via Google Translate.

Our foreign trade deficit decreased by 92.8% to 529 million dollars in October compared to the same period of the previous year……..October, our exports increased by 13.1% compared to the same month of the previous year and reached 15 billion 732 million  dollars. Our exports increased to the highest level of all time and 
broke the record of the Republican history. 
In October, our imports decreased by 23.5 percent to 16 billion 261 million dollars.

There is an intriguing hint that the Ottoman export performance may have been quite something but we learn several things. Turkey seems to have a very price competitive economy as we see both exports and imports responding in size and in short order. We also have a large slow down and indeed recessionary hint from the size of the fall in imports. Next we admire their ability to have the October figures available on the 1st of November. Also if we look at the year so far you might be surprised at one of the names below.

In January-October period, exports to Germany increased 8.7% to $ 13.5 billion, while exports to the UK increased 17.5% to $ 9.3 billion.

Also Turkey seems to have avoided the automotive slow down which today has spread to Ford suppliers in Valencia.

Thus looking ahead the inflationary episode is now fading as ironically another consequence of the lower exchange-rate which is trade looks to be moving into surplus. For once the real economy is moving as quickly as the financial one. However one aspect that we do not know yet is the size of the slow down or recession partly because a sign of it – lower imports – flatters GDP via trade and often more quickly than the other numbers we receive show the actual cause of it. If you want a Commerzbank style Turkish economy imagine all of the above with another interest-rate increase……

 

 

Advertisements

The Central Bank of Turkey has voted for Christmas

Back on the 3rd of May I pointed out that yet another feature of economics 101 was not working these days. Here was my response to interest-rate rises from the central bank of Argentina or BCRA.

This is perhaps the most common response and in my view it is the most flawed. The problem is twofold. Firstly you can end up chasing you own tail like a dog. What I mean by this is that markets can expect more interest-rate rises each time the currency falls and usually that is exactly what it does next. Why is this? Well if anticipating a 27,25%% return on your money is not doing the job is 30.25% going to do it?

Since then the BCRA  has indeed ended up chasing its own tail like a dog, as interest-rates are now an eye watering 60%. But the sequence of rises has been accompanied by further currency falls, as back then an exchange rate to the US Dollar of 21/22 ( it was a volatile day) has been replaced by 39.4. To my mind this has been influenced by the second factor I looked at back in May.

Next comes the way that markets discount this in terms of forward exchange rates which now will factor in the higher interest-rate by lowering the forward price of the Peso. So against the US Dollar it will be of the order of 28% lower in a year’s time so the expected return in each currency is equal. This should not matter but human psychology and nature intervene and it turns out often to matter and helps the currency lower which of course is exactly the wrong result.

Right now the forward price of the Argentine Peso will be heavily discounted by the 60% interest-rate. At least the Argentines got some welcome good news on the rugby front on Saturday when they beat Australia. Although they currently seem unable to avoid bad news for long.

The Argentine peso has lost more than half its value, but U2 frontman Bono is advocating for the economic well-being of the Argentine people  ( Bloomberg ).

Turkey

As you can imagine the announcement below on the 3rd of this month from the Turkish central bank or CBRT made me mull the thoughts above.

monetary stance will be adjusted at the September Monetary Policy Committee Meeting in view of the latest developments.

On the day itself ( last Thursday) the water got very muddy for a while as President Erdogan again made a case for low interest-rates. He apparently has a theory that high interest-rates create high inflation. But the CBRT is not a believer in that.

The Monetary Policy Committee (the Committee) has decided to increase the policy rate (one week repo auction rate) from 17.75 percent to 24 percent.

The consensus was that this was a good idea as highlighted by the economist Timothy Ash.

Turkey – huge move by the CBRT, doing 625bps, taking the base rate to 24%. Respect. Difficult decision set against huge political pressure, but the right should set a floor, and gives the lira and Turkish assets, banks etc a chance.

I have more than a few doubts about that. The simplest is what calculations bring you to a 6.25% rise, or was it plucked out of thin air?  Added to that is the concept of a floor and giving the currency and banks a chance. Really? The words of Newt from the film Aliens comes to mind.

It wont make any difference

Initially the Turkish Lira did respond with a bounce. It rallied to around 6.1 versus the US Dollar on the day and then pushed higher to 6.01 on Friday. In response I tweeted this.

In the case of Argentina the half-life of the currency rally was 24 hours at best….

So as I checked the situation this morning I had a wry smile as I noted the Lira had weakened to 6.26 versus the US Dollar. I also note that the coverage in the Financial Times had someone who agrees with me albeit perhaps by a different route.

But Cristian Maggio, EM strategist at TD Securities, said the central bank did not go far enough, because inflation was likely to rise beyond 20 per cent, and “higher inflation will require even higher rates”.

On the day some speculators will have got their fingers singed as the comments from President Erdogan sent the currency weaker at first, so following that the CBRT move whip sawed them. If that was a tactical plan it succeeded, but that is very different to calling this a strategic success.

Another issue is that the currency may well be even more volatile looking forwards. This is because holding a short position versus the US Dollar has a negative carry of 22% or so and against the Euro has one of 24% or so. Thus there will be a tendency to hold the Turkish Lira for the carry and then to jump out ahead of any possible bad news. The problem with that is not everyone can jump out at once! Any falls will lead to a mass exodus or panic and we know from the experience of past carry trades that the subsequent moves are often large ones.

Foreign Debt

Brad Setser has crunched the numbers on this.

Turkey has about $180 billion external debt coming due, according to the latest central bank data. And most of that is denominated in foreign currency. The Central Bank of Turkey’s foreign exchange reserves are now just over $75 billion, and the banks may have about $25 billion (or a bit less now) in foreign exchange of their own. I left out Turkey’s gold reserves, in part because they are in large part borrowed from the banks and unlikely to be usable.

The total external debt is now a bit over US $450 billion. Very little of that is the government itself although the state banks are responsible for some of it. The problem is thus one for the private-sector and the banks.

How this plays out is very hard to forecast as we do not know how many companies will not be able to pay, and how much of a domino effect that would have on other companies. Also we can be sure that both the government and CBRT will be looking to support such firms, but we can also be sure that they do not have the firepower to support all of them! This is another factor making things very volatile.

The domestic economy

There are a lot of factors at play here but let me open by linking this to the foreign debt. If we look back we would also be adding a current account deficit to the problems above but this is getting much smaller and may soon disappear. From the third of this month.

Turkey’s foreign trade deficit in August fell 58 percent on a yearly basis, according to the trade ministry’s preliminary data on Sept 1.

There should be a boost for exports which will help some but so far the main player has been a fall in imports which were 22.4% lower in the merchandise trade figures above. So a real squeeze is being applied to the economy which the GDP figures will initially record as a boost, as imports are a subtraction from GDP. So they will throw a curve ball as the situation declines.

Added to that is this which was before the latest interest-rate rise.

Switching to a year on year basis the impact so far of this new credit crunch is around three-quarters of the 2008/09 one. The new higher official interest-rate seems set to put this under further pressure as the banks tend to borrow short ( which is now much more expensive) and lend long ( which will remain relatively cheap for a while).

Comment

A major problem in this sort of scenario was explained by Carole King some years ago.

But it’s too late, baby, now it’s too late
Though we really did try to make it
Something inside has died and I can’t hide
And I just can’t fake it, Oh no no no no no

Regular readers will be aware that it is in my opinion as important when you move interest-rates as what you do. Sadly that particular boat sailed some time ago for Turkey ( and Argentina) and macho style responses that are too late may only compound the problem. Or as the CBRT release puts it.

slowdown in domestic demand accelerates

It must be a very grim time for workers and consumers in Turkey so let me end by wishing them all the best in what are hard times as well as a little humour for hard times.

 

 

 

The economic impact of the 2018 currency crises are now being felt

This morning has brought yet more developments in the ongoing currency crises of this summer. An early morning economic salvo was fired by the Turkish central bank the TCMB.

Recent developments regarding the inflation outlook indicate significant risks to price stability.
The Central Bank will take the necessary actions to support price stability.
Accordingly, in line with the previous communication, monetary stance will be adjusted at the
September Monetary Policy Committee Meeting in view of the latest developments.
The Central Bank will continue to use all available instruments in pursuit of the price stability
objective.

The press release was in response to this from the Turkish Statistical Institute.

A rise in general index was realized in CPI (2003=100) on the previous month by 2.30%, on December of the previous year by 12.29%, on same month of the previous year by 17.90% and on the twelve months moving averages basis by 12.61% in August 2018.

What we are seeing here as inflation accelerates is a consequence of the fall in the value of the Turkish Lira as it had been around 10% in the early months of this year. If we look back to last year as well the inflation boost has been ~7%, and if we look at the producer price data also released today we see that there is more to come.

Domestic producer price index (D-PPI) increased by 6.60% on monthly basis, by 25.32% on December of the previous year basis, by 32.13% on same month of the previous year basis and by 18.78% on the twelve months moving averages basis in August 2018.

We get the clearest guide to the driver here when we note what has happened in August alone to goods which are priced across the world in US Dollars.

The highest rates of monthly increase in D-PPI by sub divisions of industry were index for coke and refined petroleum products by 25.11%, for metal ores by 15.33%, for basic metals by 12.07%.

What we are seeing here are the economic consequences of a currency crisis on the real economy, as we see inflation not only considerably up but heading higher as well. This will impact directly on consumers and workers via its impact on real wages. There are other consequences as well.

7 local newspapers in İzmir all cut their Sunday editions this week due to the price of imports like paper ( @06JAnk)

Another is more sinister as there are reports of an investigation into companies which have raised prices. Also the state bank which sold some incredibly cheap US Dollars last week might wish it had not.

But returning to the TCMB it has trouble ahead as we note the last sentence of its press release as of course President Erdogan has publicly stated he is no fan of interest-rate increases. So after a rally the Turkish Lira has been slipped backwards and is at 6.61 versus the US Dollar.

The economic situation

The last few days have given us signals that the economy is not only heading south but it may be doing so at a fair old lick. Here is the Hurriyet Daily News from Saturday.

Turkey’s foreign trade deficit in August fell 58 percent on a yearly basis, according to the trade ministry’s preliminary data on Sept 1.

Trade Minister Ruhsar Pekcan said in a statement that the trade deficit of $2.48 billion last month was the lowest monthly figure in the last nine years…….She added that Turkish exports amounted to $12.4 billion in August, with a yearly fall of 6.5 percent, while the country’s imports declined by 22.4 percent to $14.8 billion.

Care is needed on two counts as there was a longish national holiday in these figures and they are just for merchandise trade. But it is hard not to note the fall in imports which is more of a plummet, and it comes on the back of this reported in the full trade figures for July released last week.

while imports decreased by 9.4% compared with July 2017.

We are seeing a large contraction in purchases of foreign goods and services and this is where initially national accounts let us down. This is because the fall in imports improves the trade balance and via that GDP ( as imports are a subtraction from GDP), so it is a bit like when in the cartoons someone runs straight off the edge of a cliff and hangs in the air before gravity takes over. It takes the national accounts a while to record that people are worse off. On the other side of the coin I think that some help will be provided by export rises and that the August fall was driven by the national holiday.

Looking ahead

The manufacturing survey of the Istanbul Chamber of Industry released this morning was rather pessimistic.

August was a month of challenging business
conditions for manufacturing firms in Istanbul.
Weakness of the Turkish lira led to strong inflationary
pressures, and contributed to slowdowns in both
output and new orders.

They also follow the Markit PMI methodology.

After posting above the 50.0 no-change mark at
51.0 in July, the headline PMI dipped back into
contractionary territory during August. At 46.3, the
PMI signalled an easing of business conditions for
the fourth time in the past five months and the most
marked moderation since July 2015.

The only flicker of good news was from exports.

There was positive news
with regards to new export orders, however, which
increased fractionally and for the second successive
month.

Cots however were reported as rising at a record rate ( since 2006) which after the inflation data should surprise no-one.

Argentina

In Argentina there has been a different response as the central bank has tried to battle a declining Peso with interest-rate increases of which the latest came only on Thursday. Those of a nervous disposition might like to sit down before reading this from the BCRA.

the Monetary Policy Committee (COPOM) of the Central Bank of the Argentine Republic (BCRA) resolved Unanimously after meeting outside the pre-established schedule to increase the monetary policy rate to 60%. Likewise, to guarantee that monetary conditions maintain their contractionary bias, COPOM undertakes not to reduce the new value of its monetary policy rate until at least December.

This is a new form of central bank Forward Guidance in that not only were interest-rate raised by an eye-watering 15%, which is only a couple of percentage or so less than even Turkey, but there was also a promise they would stay there until December. A consequence of such interest-rates was noted this morning by the Financial Times.

One of the bond market’s biggest investors has seen its flagship funds battered by the turmoil in emerging markets unleashed by Argentina’s spiralling financial crisis ………Franklin Templeton funds have lost $1.23bn in the past two weeks on just three of its biggest Argentine positions, according to FT calculations.

Those of you who have a wry sense of humour might like to mull how quickly things can change.

Argentina, which increased interest rates last week by 15 percentage points to 60 per cent, emerged as one of the hottest stories in emerging markets two years ago after the centre-right reformist Mauricio Macri came to power.

Or as David Bowie put it.

Fashion! Turn to the left
Fashion! Turn to the right
Oooh, fashion!
We are the goon squad
And we’re coming to town.

Meanwhile Argentinians will be facing soaring interest-rates for any mortgage or business borrowing rather I would imagine in the manner of their rugby team as it faces up to playing the All Black this weekend.

Comment

There is a certain irony in the war that the “currency wars” described by Brazil’s Finance Minister some 8 years ago have hit its neighbour Argentina. But of course Argentina has long had a troubled path, although we return to the concept of fashion as we recall that it was able to issue a 100 year bond in June of last year. The Vomiting Camel Formation for its likely price that I noted on the third of May performed really rather well.

However as we look at Turkey and Argentina in particular we see that the currency crises are causing inflation which will create a recession. How large and deep depends on where their currencies eventually settle as right now things could hardly be much more volatile. Yet they are far from alone as we note that the Indian Rupee has fallen to 71 versus the US Dollar and impacts on Russia, South Africa, Brazil and Indonesia. It should get more attention than it does as after all that is quite a bit of the world’s population. Also we see the power of the reserve currency the US Dollar.

 

The ECB and its Italian and Turkish problems

At the moment the European Central Bank (ECB) Governing Council is on its summer break and does not formally reconvene until the 13th of September. So I raised a wry smile when Bloomberg assured us ” The ECB is staying calm amid Turkey and Italy routs” this morning! The world does not stand still during summer and is showing more than a few signs of upset for the ECB so let us take a look.

Turkey

The very volatile nature of Turkish financial markets is an issue for the ECB and one signal of this is how such a nearby country can have such a different official interest-rate. The Turkish central bank after hints of a new 19.25% interest-rate in the melee of Monday has remained at 17.75% which is an alternative universe to the -0.4% deposit rate of the ECB. It is hard to believe Greece and Turkey are neighbours when you look at that gap.

Next comes the exchange rate where at the start of 2018 some 4.55 Turkish Lira were required to buy one Euro as opposed to the 6.72 required as I type this. Even that is a fair retracement of the surge which saw it just fail to make 8 only on Monday. Apart from being a dizzying whirl recently we can see that the fall this year must have made trade difficult. As to how much trade there is we need to switch to the European Union about which we were told this in April.

  • In 2017, among the EU’s trading partners, Turkey was the fifth largest partner for exports from the EU and the sixth largest partner for imports to the EU.
  • The EU’s trade surplus with Turkey has fallen from a peak of EUR 27 billion in 2013 to EUR 15 billion in 2017.
  • Manufactured goods make up 81 % of EU exports to Turkey and 89 % of EU imports from Turkey.
  • In 2017, Germany was the EU’s largest import (EUR 14 billion) and export (EUR 22 billion) partner with Turkey.
  • Germany also had the largest trade surplus (EUR 8 billion) with Turkey while Slovenia had the largest deficit (EUR 1.5 billion).

If we just switch to exports then we see the importance of Turkey.

Germany was also the largest exporter (EUR 21.8 billion) to Turkey followed by Italy (EUR 10.1 billion) and the United Kingdom (EUR 8.4 billion). Almost a quarter of Bulgaria’s extra-EU exports (23 %) were destined for Turkey. Greece (15 %) and Romania (14 %) also had high shares while all other Member States had shares below 9 %.

Of course some of those countries are not the responsibility of the ECB but we do get an idea of vulnerabilities such as the ability of Turkish consumers to buy German cars. Also Italy with its own economic issues that I will come on to later can do without any fall in exports. Even worse for Greece.

Right in the ECB’s orbit however was this from the Financial Times last week about risks to the “precious”.

The eurozone’s chief financial watchdog has become concerned about the exposure of some of the currency area’s biggest lenders to Turkey — chiefly BBVA, UniCredit and BNP Paribas — in light of the lira’s dramatic fall…….Spanish banks are owed $82.3bn by Turkish borrowers, French banks are owed $38.4bn and Italian lenders $17bn in a mix of local and foreign currencies. Banks’ Turkish subsidiaries tend to lend in local currency.

There have been arguments since then as to exactly the size of the risk but it is clear that there is an issue. Of course if we bring the exchange-rate back in it looks much less at 6.7 to the Euro than it did at 8 but to any proper analysis that move this week may well be as dangerous as the fall. Looked at through the eyes of an ex-option trader (me) you see that a short derivative position might have been hedged in the panic ( so towards 8) but the catch is that you would be long the Euro up there just in time for it to drop! So you lose both ways. We never really find out about this sort of thing until it has really badly gone wrong.

Italy

In a way much of the problem here has been exemplified by the dreadful Autostrada bridge collapse. For a start how does that happen in a first world country? Then even worse everyone seems to be blaming everyone else. If we move to the direct beat of th ECB there is the ongoing economic growth issue.

In the second quarter of 2018 Italian economy slowed down, as suggested in the previous months by the leading indicator. The GDP quarterly slightly decelerated (+0.2% compared to +0.3% Q1,)

That brings Italy back to my long running theme that it struggles to have economic growth above 1%. Indeed as this still represents a period where monetary policy was very expansionary there will be fears for what will happen as it gets wound back.

On the latter subject of reducing and then an end to the QE program there was this on Monday.

The economic spokesman of Italy’s ruling League party warned on Monday that unless the European Central Bank offers a guarantee to cap yield spreads in the euro zone, the euro will collapse………….Borghi said the ECB should guarantee that yield spreads between euro zone government bonds not exceed a certain level, suggesting 150 basis points between the yields of any two sovereign bonds as a reasonable maximum. ( Reuters)

That sort of statement opens more than one can of worms. The simplest is just to compare that with where we are which is 284 basis points or 2.84%. So he is looking for the ECB to back stop the Italian bond market and his own spending plans a subject which has arisen before. No doubt this is driven by the rise in the ten-year yield of Italy which is now 3.14% which is not historically high but since then Italy’s national debt and therefore borrowing needs has risen meaning that matters tighten at lower yields than they used to.

Next comes the fact that even the ECB which in spite of calling itself a “rules based organisation” has operated at least to some extent by making them up as it goes along. But a programme just to help Italy would be even nearer to overt monetary financing than what we have seen so far. Other nations taxpayers would wonder why it was being singled out for favourable treatment. This would be especially true in Greece which only a week ago found that a waiver for its collateral at the ECB had ended.

Greek banks borrow just over 8 billion from the ECB in longer-term refinancing operations and now need to post a new type of collateral to maintain their access. ( Reuters)

Meanwhile there is the ongoing issue of the Italian banks and the irony of the Turkish situation is the way that Unicredit which was supposed to be escaping the noose may have found a way of putting its neck back in it.

Comment

Having looked at particular issues it is time to bring the analysis back to the day job which is monetary policy. This morning brought troubling news for those who are in the “pump it up” camp.

The euro area annual inflation rate was 2.1% in July 2018, up from 2.0% in June 2018. A year earlier, the rate was
1.3%.

Thus it has for now achieved its inflation objective and in fact it is a little above the 1.97% indicated by the previous President Jean-Claude Trichet. So those wanting more only have the “core” or excluding energy number at 1.4% to support them. They can also throw in the fact that economic growth has slowed in 2018 but also have to face the issue that even Mario Draghi regards this as pretty much a normal level.

Seasonally adjusted GDP rose by 0.4% in both the euro area (EA19) and the EU28……..Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.2% in both the euro area and the EU28.

Thus the ECB moves forwards with its monetary policy locked on course. It has no intention of raising interest-rates and a cut would provoke questions as after all it has told us things are going well. The QE programme is being trimmed in flow terms and it will not be long before that stops. What it has now are the boring parts of central banking such as bank supervision but in the case of Euro area banks in Turkey that would look like closing the stable door long after the horse has bolted.

Of course it could intervene against the Turkish Lira to help provide some stability and to help Euro area exporters. But I think we all know it would only do that if it thought it would help the banks. Also if we take the example of right now and the fall to 6.91 versus the Euro whilst I have been typing this it would no doubt attract the attention of the Donald and his twitter feed plunging the ECB into a political morass.  Such thoughts will have Mario Draghi reaching for another glass of Chianti on his summer break.

 

 

The economic consequences of a falling Turkish Lira

Over the past few days we have seen the expected height of summer lull punctured by events in Turkey. This morning there has been a signal that this has become a wider crisis as our measure of this the Japanese Yen has rallied to 110.2 versus the US Dollar. It has pushed the Euro down 1.2 to 125.3 Yen as well. That sets the tone for equity markets as well via its inverse relationship with the Nikkei 225 equity index which was done 414 points at 21884. Another more domestic sign is the search for scapegoats or as they are called these days financial terrorists.

*TURKEY STARTS PROBE ON 346 SOCIAL MEDIA ACCOUNTS ON LIRA: AA ( @Sunchartist )

The most amusing response to this I have seen is that they should start with @realdonaldtrump.

What has happened?

Essentially the dam broke on the exchange rate on Friday. In the early hours it was trading at 5.6 versus the US Dollar then as Paul Simon would put it the Lira began “slip sliding away” . Then the man who may well now be financial terrorist number one put the boot in showing that he will to coin a phrase kick a man when he is down.

I have just authorized a doubling of Tariffs on Steel and Aluminum with respect to Turkey as their currency, the Turkish Lira, slides rapidly downward against our very strong Dollar! Aluminum will now be 20% and Steel 50%. Our relations with Turkey are not good at this time!

It was time to finish with Paul Simon and replace him with “trouble,trouble,trouble” by Taylor Swift as the already weak Turkish Lira plunged into the high sixes versus the US Dollar. As ever there is doubt as to the exact bottom but it closed just below 6.5 so in a broad sweep we are looking at a 16% fall on the day. Last night in the thin Pacific markets it quickly went above 7 and if my chart if any guide ( 7.2 was reported at the time) the drop went to 7.13. So another sign of a currency crisis is ticked off as we note the doubt over various levels but if course the trend was very clear.

The official response

There were various speeches whilst mostly seemed to be calling for divine intervention. This seemed to remind people even more of a company which of course famously claimed to be doing God’s work.

The particular target of 7.1 had seemed so far away when it was pointed out but suddenly it was near on Friday and exceeded overnight. As ever when there are challenges to the “precious” there is an immediate response from the authorities.

To support effective functioning of financial markets and flexibility of the banks in their liquidity management;

  • Turkish lira reserve requirement ratios have been reduced by 250 basis points for all maturity brackets.
  • Reserve requirement ratios for non-core FX liabilities have been reduced by 400 basis points.
  • The maximum average maintenance facility for FX liabilities has been raised to 8 percent.
  • In addition to US dollars, euro can be used for the maintenance against Turkish lira reserves under the reserve options mechanism.

That was from the central bank or CBRT which estimated the benefit as being this.

With this revision, approximately 10 billion TL, 6 billion US dollars, and 3 billion US dollars equivalent of gold liquidity will be provided to the financial system.

I guess it felt it had to start with the Turkish Lira element but these days that is the smaller part. This also adds to the action last Monday which added some 2.2 billion US Dollars of liquidity. So more today and an explicit mention of a Turkish Lira element.

There was also a press release on financial markets which did at one point more explicitly touch on the foreign exchange market.

3) Collateral FX deposit limits for Turkish lira transactions of banks have been raised to 20 billion euros from 7,2 billion euros.

This did help for a while as the Turkish Lira went back to Friday’s close but it has not lasted as it is 6.83 versus the US Dollar as I type this.

Why does this matter?

Turkey

The ordinary person is already being hit by the past currency falls and now will see inflation head even higher than the 15.85% reported in July.  There was some extra on the way as the producer price index rose to 25% but of course that is behind the times now. The author Louis Fishman who writes about Turkey crunched some numbers.

For many of middle class, a good wage for last 3-4 years has been around 6000-7000 Turkish Lira a month. It has unfortunately decreased in the dollar rate but was still sustainable. This is no longer true. Someone who made 6500 TL in January 2015 made 2,826$ a month. Now: 1,014$.

For a while there will be two situations as foreign goods get much more expensive and domestic ones may not. But as we have noted with the inflation data over time domestic prices rise too.

We have note before the foreign currency borrowing in Turkey which will be feeling like a noose around the neck of some companies right now. From the 13th of July/

Since 2003 $95bn has been invested into the country’s energy sector, of which $51bn remains to be paid. This figure represents 15% of the $340bn owed by non-financial companies in overseas liabilities, according to data from the nation’s central bank. ( Power Technology)

So there will be increasing foreign currency stresses as well as bank stresses in the system right now. The financial chain will be under a lot of strain as we wait to see what turns out to be the weakest link. So far today bank share prices have fallen by around 10% and of course that is in Turkish Lira.

Internationally

As ever we start with the banks where in terms of scale the situation is led by the Spanish and then the French banks with BBVA and BNP being singled out. Italy is under pressure too via Unicredit but this is more that it had troubles in the first place rather than being at the top of the list. There is some UK risk but so far the accident prone RBS does not seem to have been especially involved in this particular accident.

Wider still we have seen currency moves with the US Dollar higher but the peak so far seems to be the South African Rand which has fallen over 3% at one point today adding to past falls. Of course again there is a chain here around various financial markets as we wait to see if anything breaks.

Comment

These situations require some perspective as it is easy to get too caught up in the melee. So let us go back to the 8th of June 2015 where we looked at this.

Turkey’s lira weakened to an all-time low……..The currency tumbled as much as 5.2 percent…….The lira dropped the most since October 2008 on a closing basis to 2.8096 per dollar……..The Borsa Istanbul 100 Index sank 8.2 percent at the open of trading.

Familiar themes although of course the levels were very different. Were there signs of “trouble,trouble,trouble”?

So we have an economy which has chosen economic growth as its policy aim and it has ignored inflation and trade issues.

Since then Turkey has seen sustained inflation and trade problems leading us to the source of where we are now. I see more than a few blaming the tightening of US monetary policy and what is called QT as drivers here but I think they are tactical additions on a strategic trend which is better illustrated by this from the 13th of July.

Turkey’s annual current account deficit in 2017 was around $47.3 billion, compared to the previous year’s figure of $33.1 billion.

As ever if you get ahead of the rush you can feel good as these from the 3rd of May highlight from Lionel Barber.

Good market spot: Turks are buying gold to hedge against booming inflation and a falling currency

Which got this reply from Henry Pryor.

Anecdotally central London agents tell me they are seeing an increase in Turkish buyers this year…

Or if you do not want to bother with the analysis just take note of the establishment view.

World Bank Group President Jim Yong Kim from October 2013.

Turkey’s economic achievements are an inspiration for many other developing countries

 

How not to deal with a foreign exchange crisis

Just over three months ago on the third of May I gave some suggestions as to how to deal with a foreign exchange crisis using the hot topics at the time of Argentina and Turkey. Back then the Argentine newspaper had reported this.

On Wednesday, the US currency jumped again to reach $ 21.52 in the retail market and $ 21.18 in the wholesaler. It went up 5% in the week…….. And the Argentine peso is the currency that fell the most in the year against the dollar (12.5%) followed by the Russian ruble (9%).

Actually the R(o)uble is currently in a soft patch but it is slightly different due to its role as a petro-currency, But returning to Argentina the central bank had a few days earlier done this with interest-rates as they raised them by “300 basis points to 30.25%.”

I suggested that this was unlikely to work.

Firstly you can end up chasing you own tail like a dog. What I mean by this is that markets can expect more interest-rate rises each time the currency falls and usually that is exactly what it does next. Why is this? Well if anticipating a 27,25%% return on your money is not doing the job is 30.25% going to do it?

Actually they did not even get out of that day as the dam broke quickly and interest rates were raised by 3% later that day. Of course that just provokes the same question if a 3% rise does not work why do you think another 3% will? Well my logic applied again as the next day the central bank announced this.

It was resolved to increase the monetary policy rate by 675 points to 40%.

Frankly they were in utter disarray as they proved my point at what was extraordinary speed. Such an interest-rate will have quite a contractionary influence on an economy if sustained and so far it has been as this announcement from Tuesday informs us.

the Monetary Policy Committee (COPOM) of the Central Bank of the Argentine Republic (BCRA) unanimously resolved to define the Liquidity Rate (LELIQ) ) to 7 days as the new monetary policy rate and set it at 40%.

They can have as many new rates as they like but reality is still the same.

What about the Peso?

If we return to Clarin to see what is being reported in Argentina then it is this.

After having closed stable in a day in which the Central Bank maintained the rates, the dollar rose this Wednesday 20 cents in the banks . The average of the entities surveyed by the BCRA showed a closing value of $ 28.23.

In the same sense, at wholesale level the currency increased 23 cents, to $ 27.63 .

So that is around 6 more Pesos per US Dollar. I am not sure at exactly what point a currency fall becomes a plunge but 56% over the past year is hard to argue against.

Along the way Argentina decided that is had to go to the International Monetary Fund or IMF. Although how they both think moving the goalposts will help I am not sure.

 In particular, the central bank has adopted a new, more credible path of inflation targets (for example, the inflation target for end-2019 moved from 10 to 17 percent).

Also this is one way of putting it.

The exchange rate regime is a big change. It is now floating, not fixed, so it’s working as a shock absorber.

Also as I understand it this is rather economical with the truth.

Banks and the private sector also operate without money borrowed in foreign currency, so their balance sheets are not at risk from a depreciation of the peso.

It seems that the Governor of the BCRA thinks so too if this from his annual speech in January is any guide.

As a result of these measures, interest rates in dollars went down from 5%-6% annually by late 2015 to 2%-3% annually today, and lending in foreign currency went up 379% since then, from a stock of U$S 2.9 billion to 14 billion dollars today.

Perhaps the IMF were trying to deflect attention from the foreign currency borrowings of the Argentine state that the central bank had been helping to finance. You may remember the Vomiting Camel Formation that some drew on the 100 year bonds that had been issued in US Dollars by Argentina.

Turkey

Yesterday brought an example of the opposite line of thought to mine as I note this from Bloomberg.

Turkey must hike rates to 23% as the crisis gets worse, Investec says

This was presumably driven by this from Reuters.

The currency had fallen as much as 5.5 percent on Monday to 5.4250 per dollar, an all-time low and its biggest intraday drop in nearly a decade, after Washington said it was reviewing access to the U.S. market for Turkey’s exports.

Actually the territory gets even more familiar because back on June 7th Reuters told us this.

Rates rise by 125 basis points, more than expected……..Turkey’s central bank ramped up its benchmark interest rate to 17.75 percent on Thursday, taking another step to assert its independence, two weeks after an emergency rate hike and just ahead of elections.

No doubt the cheerleaders would have proclaimed success as this happened.

The lira strengthened to 4.4560 against the dollar after the rate rise from 4.5799 just before. It was trading at 4.4830 at 1605 GMT.

However they would have needed the speed of Dina Asher Smith to get out of Dodge City in time if we note where the Turkish Lira is now. So an interest-rate rise that was more than expected did not work and of course it was on top of a previous failure in this regard.

So if we stay with Investec we are left wondering about the case for a rise to 23% or 4.25% more. Especially if we note that such a rise would not even match Monday’s fall in the Lira. The environment is very volatile and the Lita has hit another new low this morning although it is jumping around.

If you want a sense of perspective well if we look back to May 3rd some got ahead of the game.

Good market spot: Turks are buying gold to hedge against booming inflation and a falling currency ( Lionel Barber)

Anecdotally central London agents tell me they are seeing an increase in Turkish buyers this year… ( Henry Pryor)

Comment

These are situations which were described rather aptly by the band Hard-Fi.

Can you feel it? Feel the pressure? Rising?
Pressure
Pressure
Pressure, Pressure, Pressure
Feel the pressure
Pressure
Pressure
Pressure

In that sense perhaps we should cut central bankers a little slack as after all the academics which are often appointed will hardly have any experience of this sort of thing. Then again that begs the question if they are the right sort of person? I recall when the UK was in such a melee back in 1992 that the establishment and I am including the Bank of England and the government in this was simply unable to cope with events as each £500 million reserve tranche disappeared even after promising interest-rate rises of 5%. What a day and night that was…..

In my opinion a combination of Bananarama and the Fun Boy Three gave some coded advice.

It ain’t what you do it’s the way that you do it
It ain’t what you do it’s the way that you do it
It ain’t what you do it’s the way that you do it
And that’s what gets results

As to Turkey the official view is that it’s all fine.

*TURKEY SEES NO FX, LIQUIDITY RISK FOR COMPANIES, BANKS ( h/t @Macroandchill )

What is the scale of the Turkish economic problem?

Recently I watched a BBC Four documentary series on the House of Osman or as we call it the Ottoman Empire which extended into south-east Europe as well as around the Mediterranean into North Africa. Now we associate it with decline and the phrase “young Turks” which oddly seems to have given inspiration to Rod Stewart but back in time it was a thriving Empire managing to rule parts of the world that we now consider not only as hot-spots but maybe too hot to handle. Now we find that the subject of a possible empire is in the news yet again.

Investors have been unnerved by Mr Erdogan’s decision to place his son-in-law in charge of the economy brief while sidelining familiar and respected former ministers. ( Financial Times)

Promoting family members is something of an in thing as is some of the language used.

Berat Albayrak, who is also Mr Erdogan’s son-in-law, said the central bank would be effective “like never before” and promised to bring soaring inflation down into the single digits “in the shortest time possible”.
“Speculation about the independence and decision-making mechanisms of the central bank is unacceptable,” he added. “A central bank that is effective like never before will be one of the fundamental aims of the policies of the new era.”

He failed however to use the trump card of a “bigly”. Of course the Financial Times somehow still manages to believe in central bank independence whereas we abandoned such thoughts years ago. Whilst the example below is admittedly extreme the theme is familiar.

Turkey’s central bank announced three interest rate rises during the campaign for June 24 elections, with a cumulative total of 500 basis points. The bank’s benchmark lending rate stands at 17.75 per cent.

So up,up and indeed up and away whereas the rhetoric is rather different. This is Hurriyet Daily News quoting President Erdogan on the 11th of May

“My belief is that interest rates are the mother of all evils. Interest rates are the cause of inflation. Inflation is a result, not a cause. We need to push down interest rates,”

As we wonder if Bank of England Governor Mark Carney was taking notes it is time to switch to the economic impact of all of this. The first factor we have already noted which is an interest-rate of 17.75% which is out of kilter with the economic times by some distance. As opposed to the -0.4% of neighbouring Greece or the 0.1% of Israel if we look the other way. So a break is being applied.

The Exchange-Rate

We can switch quickly to this as we know we only get rises in interest-rates like this if the national currency is in what Taylor Swift would call “trouble,trouble,trouble”. The latest Central Bank of Turkey minutes puts it somewhat euphemistically.

exchange rate developments

Or as the Hurriyet Daily News puts it.

The lira weakened to a record low of 4.9767 against the dollar late on July 11. The currency opened the July 12 trading at around 4.83 against the greenback.

The lira has shed nearly 25 percent of its value against the U.S. currency so far this year.

If we look at the pattern we see that the rate has been heading south for some time as five years ago it was at 2.04. However an acceleration started at the end of April when it was 4.05. Or returning to Ms Swift.

And the haters gonna hate, hate, hate, hate, hate

If we stay with financial markets there is a familiar sequence of responses to this.

Fall-out from Turkey’s tumbling lira hammered banking shares on July 11, sending the Istanbul stock market to its biggest one-day fall in two years.

The main share index dropped more than 5 percent while bank stocks lost 9 percent in their worst day for five years.

The yield on Turkey’s benchmark 10-year bond rose to 18.48 percent from 17.36 percent at close on July 10.

Central bankers will be panicking at all the negative wealth effects here. Care is needed as in such volatile circumstances markets ebb and flow quickly although it has mainly been ebb. Also the official interest-rate and bond yield numbers remind me of my analysis of how to deal with a foreign exchange crisis on May 3rd. If you think that a currency is collapsing then even ~18% interest-rates do not help much and even worse via forward or futures calculations it makes it look like the currency will drop even further. At some point investors will think things have stabilised and especially in these times will pile in for a juicy yield but when?

I’ll never miss a beat, I’m lightning on my feet

The trouble is that in the meantime you have slammed the brakes on your domestic economy.

Inflation

This is a consequence of the lower currency as the price of imported goods and services rises. For a while existing contracts may be a shelter but then it hits home.

In May, consumer prices rose by 1.62 percent and annual inflation increased by 1.30 points to 12.15 percent. The uptick in inflation spread across subgroups in this period ( CBRT)

Last week we learned that the CBRT was right to expect more bad news.

Inflation rose to 15.39 percent year-on-year, the highest annual rate since 2004 after a new method of calculating price rises was introduced, and month-on-month CPI inflation leapt to 2.61 percent – nearly double the forecast in a Reuters poll.

It looks set to go higher still.

Trade

Whilst a lower currency boosts an economy as price competitive exports and imports respond this takes time. Before they do you are actually in a worse situation as your imports cost more as the J-Curve and Reverse J-Curve entwine. Thus we get this.

According to the data released on July 11, the current account deficit rose to $5.9 billion in May from $5.4 billion in the corresponding month last year, with a nearly 9.6 percent year-on-year increase. ( Hurriyet Daily News)…….The country’s 12-month rolling deficit reached $57.6 billion in May, the data also showed.

This compares to these.

Turkey’s annual current account deficit in 2017 was around $47.3 billion, compared to the previous year’s figure of $33.1 billion.

Comment

Much of this feels like the UK in the 1970s although to be fair Turkish inflation it has yet to hit the 26.9% seen in the summer of 1975. A sharp brake has been applied to the economy via the higher cost of imports and via higher interest-rates. If we move to the business sector there will also be an impact from this.

The Turkish energy sector is facing an increasingly unstable situation with a rapidly declining lira making it impossible to repay billions of dollars’ worth of loans accumulated over the past 15 years.

Since 2003 $95bn has been invested into the country’s energy sector, of which $51bn remains to be paid. This figure represents 15% of the $340bn owed by non-financial companies in overseas liabilities, according to data from the nation’s central bank. ( Power Technology)

This is also familiar as countries which are in danger of trouble make it worse by borrowing in a foreign currency because it is cheaper in interest-rate terms. After all what could go wrong? It is also reminiscent of the foreign currency mortgage crisis of parts of south-eastern Europe. At least they did not borrow in Swiss Francs.

A recession is a danger as this hits and we will have to wait and see what develops but as to the talk of plenty of measures that sounds a little like capital controls to me. However the official view echoes Ms. Swift again.

I shake it off, I shake it off
I shake it off, I shake it off