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.

 

 

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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

 

 

How to deal with a foreign-exchange crisis

This week has seen at least a couple of examples of currencies that appear to have gone into free fall. Let us open with the Argentine Peso which was singing along to “Down,Down” by Status Quo yesterday. From the Argentine newspaper Clarin via Google Translate

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.

The abrupt movement of a variable as sensitive as the exchange rate alters the nerves of investors, the general public and -although they deny it- of the Government itself, the last thing it wants is that in the middle of the hard fight to lower the inflation, the price of the dollar occupies large spaces in the media and in public conversation.

What they do not tell us is that this was a new low for the Peso. Actually we get an unusual perspective in that the paper gives a link to exchange rates on the front page  of its website. The situation so far this year is shown later as is a major factor in it.

Is that almost all currencies -especially those of the emerging world- are being devalued against the dollar. 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%).

How can a central bank respond?

Interest Rates

From the Argentine central bank or BCRA. You might like to sit down before you read it.

Buenos Aires, April 27, 2018. Given the dynamics acquired by the exchange market, the Monetary Policy Council of the Central Bank of the Argentine Republic met outside of its pre-established schedule and decided to increase its monetary policy rate, the center of the corridor of passes to 7 days, in 300 basis points to 30.25%. He made this decision with the aim of guaranteeing the disinflation process and is ready to act again if necessary.

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? Unlikely in my view as we note that the currency has fallen 5% this week.

On the other side of the coin interest-rates in one place in particular are expected to have an effect. From a speech by BCRA Governor Federico Sturzenegger on the 23rd of April.

This week at the Fund meetings, for example, I saw scenarios with 9 hikes in the FED policy rate over this year and next. But most people did not believe that was the most likely scenario. Yet, whatever form monetary policy normalization takes, certainly such a move will have ample repercussions on the rest of world.

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.

So what should you do? Well respond to inflation changes are per your mandate as per this but then hold your nerve.

The Central Bank will continue using all the tools at its disposal and will conduct its monetary policy to reach its intermediate target of 15% in 2018.

Otherwise each currency fall you will be raising interest-rates and again a downwards spiral can result.

Foreign Exchange Reserves

This is often the first line of defence or can be combined with an interest-rate rise. From Clarin again.

plus the almost 5,000 million dollars of the reserves that sold in the last week of April and the start of May,

The catch is that it is not working although until the interest-rate rise last week it was not helped by the last move being a cut in interest-rates. Also if we return to the speech by the BCRA Governor Argentina was in a really bad place only a couple of years ago.

As we took over from the previous government, our international reserves were reaching very low levels. In fact, what we called net reserves, that is, our reserves net of our obligation in foreign currency, were negative.

In fact it was a real mess.

To make things worse, the previous government had sold USD futures for about the equivalent of a third of the monetary base at off market prices.

In fact it bought its new reserves from the Argentine government.

The combination of the need to accumulate reserves, plus the fact that the government had an excess supply of dollars, as it was financing abroad its gradual fiscal convergence, implied a natural agreement by which the Central Bank would buy these excess dollars to the Treasury, sterilizing afterwards the pesos issued by issuing short-term Central Bank debt.

Okay so now it has some reserves but there is a catch which is that whilst they are getting more valuable in Peso terms of course that is only for the amount left as they are being used up. This is the problem here as people focus on the amounts used and the rate of attrition. Even Russia suffered from this if you recall and it had and has ready sources of foreign exchange from its oil and commodity exports. The IMF estimated at the end of last year that Argentina would have US $50.7 billion of foreign exchange reserves this year and that they would grow in subsequent years. Mind you they also forecast a rising Peso so it was far from their finest hour.

Capital Controls

Argentina did have these but scrapped them. From the Governor’s speech.

The third change occurred at the beginning of 2017, when the government released the remaining capital controls

They can help but problems do arise of which the worst is the development of an official and unofficial exchange-rate. I am sure you can figure out which will be higher than the other. Or the US Dollar becomes the currency most used.

Comment

So a central bank can fight a currency decline but the truth is that it can only do so on a temporary basis. The Swiss Franc has taught us that this is true in the case of currency strength where the central bank in theory at least is in a much stronger position. Oh and by temporary I mean the definition used by the ordinary person not the perversion used by central bankers.

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. As to building up foreign exchange reserves by borrowing it is hard not to think of this. From City-AM last June.

About a year after emerging from default, Argentina has surprised investors by offering a 100-year bond.

The US-dollar-denominated bond is offered with a potential 8.25 per cent yield.

Actually it feels like everyone lost there which cannot be true. Argentina has to pay the interest with increasingly devalued Pesos and the price of the bond has to give you a clue been described like this.

Of course Argentina did gain on the initial transaction.

Moving onto Turkey which this morning has joined the club with a new low for the Lira I note this from the editor of the Financial Times 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…

Which gives me another question. Is London property considered to be the worlds safe asset and please note I typed considered to be?

Oh and helping with this sort of thing was the original role of the IMF as opposed to the way it intervened in the fiscal crisis in part of southern Europe.

This article came to late for the BCRA it would appear as just before 5 pm UK time they raised interest-rates to 33.25%. I would place a link bit nobody seems to have told the English version of their website yet.

 

The US interest-rate rise conundrum continues

It was only yesterday that I analysed the risk that the European Central Bank eases monetary policy again. In essence it boils down to the level of the Euro with a soupcon of oil price influence. But there is quite a list of central banks considering easing policy further to join the 60 or so moves we have seen so far in 2015. However the major central bank which is the US Federal Reserve wants us to believe that it will raise interest-rates under its policy of Forward Guidance and wants us to forget the couple of false starts on that front that 2015 has already seen!

Over the past week or so we have had a veritable smorgasboard of views from Federal Reserve voting members from a definite yes (Esther George) to a hint of further easing and hence no (Kochlerkota). The majority view is this from Vice-ChairMAN Stanley Fischer in his speech at Jackson Hole.

With inflation low, we can probably remove accommodation at a gradual pace. Yet, because monetary policy influences real activity with a substantial lag, we should not wait until inflation is back to 2 percent to begin tightening.

The tenet of his speech is that inflation is on the way back to 2% with the implied view that interest-rates need to rise soon in response. That is what we are supposed to think.

Currency Wars

I note that Mr.Fischer also steers us towards this in his speech.

The rise in the dollar since last summer, of about 17 percent in nominal terms, with its associated declines in non-oil import prices, could plausibly be holding down core inflation quite noticeably this year.

This is a monetary tightening although with the US Dollar being the reserve currency with the majority of commodities priced in it there is a smaller influence than say the UK. I note he also points us to an economic model which suggests the impact will not last long.

Finally, PCE inflation shows a sizeable but transient drop due to declining import prices.

The United States is traditionally not that concerned about the impact of its monetary policy on others but the flip side of the appreciation discussed has been seen just this morning. From Darlington Dick.

TURKISH LIRA FALLS TO RECORD LOW (2.96) VS DOLLAR ON CLOSING BASIS

The so-called emerging market currencies are getting what the Duke of Wellington called a “damned hard pounding” and if we return to the originators of the Currency Wars theme then even an Olympics and a football World Cup are being cast aside. From Bloomberg.

Brazil’s real led losses among major currencies and fell to a new 12-year low……..The currency declined for a fourth straight day, falling 1.7 percent to 3.7611 per dollar, the weakest level since 2002.

Poor Brazil has been alternately frozen (the original Currency Wars complaint) and then heated up by the changes in perceived US monetary policy, like a football really.

The International Monetary Fund

This seems to get ever more concerned about a rise in US interest-rates as its latest statement makes clear.

Advanced economies should maintain supportive policies. In most advanced economies substantial output gaps and below-target inflation suggest that the monetary stance must stay accommodative.

Does it mean the US? Well the specific section carries on the theme.

In the United States, growth in the first half of the year was 1.8 percent, compared to 3.8 percent in the 2nd half of 2014. The growth slowdown reflected harsh winter weather, port closures, and a strong downsizing of capital expenditure in the oil sector in Q1, and relatively sluggish business investment in Q2. Recent revisions in the U.S. national accounts suggest that productivity growth during 2012-14 was lower than previously thought.

What about going forwards?

Longer-term growth prospects are weaker, reflecting an aging population and low total factor productivity growth.

Indeed the IMF goes so far as to drop quite a hint.

with little evidence of meaningful wage and price pressures so far,

It also mimics the “Warning,Warning” of the robot Robbie in the Swiss Family Robinson films.

Risks are tilted to the downside, and a simultaneous realization of some of these risks would imply a much weaker outlook.

There is also a hint as it turns out in the location of the G-20 meeting which is Ankara where US delegates will find that there US Dollar expenses will go much further than they did.

The Beige Book

This is where the various regional Federal Reserves take a look at the economy in their area and the latest version was released last night. So what do we learn?

Six Districts cited moderate growth while New York, Philadelphia, Atlanta, Kansas City, and Dallas reported modest increases in activity. The Cleveland District noted only slight growth since the last report. In most cases, these recent results represented a continuation of the overall pace reported in the July Beige Book.

So good news but hardly signs of a boom and whilst some see it in the labour market section I am less convinced.

Most Districts reported modest to moderate growth in labor demand, although Boston, Cleveland, and Dallas cited only slight increases in hiring. This tightening of labor markets was said to be pushing wages up slightly in selected industries or occupations, especially in the New York, Cleveland, St. Louis, and San Francisco Districts.

If there is a boom this is in a familiar area.

Reports on residential and commercial real estate markets across the Districts were mostly positive. Existing home sales and residential leasing widely improved, with home prices moving up in most areas.

This backs up a theme from the CoreLogic numbers released yesterday as well.

On a month-over-month basis, home prices increased by 1.7 percent in July compared to June data…..Home prices, including distressed sales, increased 6.9 percent in July 2015 compared to July 2014. June marks the 41st consecutive month of year-over-year home price gains.

A central bank rasing interest-rates to slow house price growth? I will believe that when I see it! After all they are presented as wealth gains and not inflation in modern central banking theory. Also on a technical note the US uses rents and not prices in its CPI (Consumer inflation) measure. It is one of the factors holding it up with primary rents rising at just under 3.6% and maybe set for a rise.

Comment

Tomorrow sees the US employment and non-farm payrolls report for August. Regularly we see moves which are statistically insignificant considered as policy moving events! In case you were wondering the Bureau of Labor Statistics estimates that for July the statistically significant change was 107,400. Rather gives a perspective to a 10k or 20k difference to expectations doesn’t it? That is before the fact that the two different surveys often give conflicting answers.

However the US Federal Reserve persists with the mantra that an interest-rate rise is on its way. In itself a 0.25% increase is not much of a change but that ignores how tightly wired the world financial system and economy remains. So the song for September 17th is from Daniel Bedingfield.

If only I could get through this
If only I could get through this
If only I could get through this
God, God gotta help me get through this

Perhaps the Federal Reserve could play it as background music. although surely they must fear what might happen if they raise and therefore will delay yet again. If so perhaps the song should be from Green Day.

Summer has come and passed
The innocent can never last
Wake me up when September ends

What is the outlook for the economy of Turkey?

It is not that often that Turkey makes the news headlines. Mostly if it does it is a reflection of the troubles on and at its borders or in a more economic sense movement in its currency the Turkish Lira which has been volatile in recent times. However the setback for the ruling AK Party as the election results came in has certainly stirred up the financial markets this morning. The first impact has been on the Turkish Kira which has fallen heavily. From Bloomberg.

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.

Okay so we get the message there and the Turkish equity market has had better days too.

The Borsa Istanbul 100 Index sank 8.2 percent at the open of trading.

So it was a very bad weekend to be holding Turkish equities if you are a foreign investor as your price falls are exacerbated by the currency fall. Just to make a grim triple-play you will probably not be surprised to read that the bond market fell as well.

The yield on the 10-year government bond jumped 55 basis points to 9.87 percent, the highest since September 2014 on a closing basis.

So we immediately learn one thing which is that bond yields in Turkey are much higher than what usually passes as “normal” in these times. Even Portugal with its troubled debt path only has a ten-year yield just nudging 3% or less than a third of the Turkish level. Mind you according to the Governor of Austria’s central bank Ewald Nowotny it is apparently Turkey which is better off.

‘s Nowotny says rising 10yr yields are a ‘success story’ (h/t )

No doubt when yields were falling he considered that to be a success too! I somewhat doubt whether  eitherTurkey or Turkish investors agree with him in his latest comments.

The Turkish Lira

Central bankers do not like to highlight the fact that their currency has fallen so the TCMB (Turkish central bank) puts it thus in its monthly analysis.

recently elevated volatility in the exchange rates…… the recently-elevated volatility in exchange rates.

Usually such talk is a sign to be afraid and to be very afraid! Actually the Turkish Lira has been on a mostly downwards path for some time. It passed 1.5 to the US Dollar in late 2010 then passed 2 in the late summer of 2013 and opened 2015 at 2.35. So we fear inflation and also note that much of the beneficial effect of falling oil and commodity prices has been lost.

Inflation

As pointed out above a falling exchange-rate is a close bedfellow of problems with inflation so let us look at the TCMB numbers from Friday.

In May, consumer prices rose by 0.56 percent, pushing the annual consumer inflation upwards by 0.18 points to 8.09 percent.

This of course is unusally high for these times and both Turkish workers and consumers will rue the latest trends.

the contribution of the energy group and core goods to annual CPI inflation increased by 0.24 point and 0.30 point, respectively in May. The food group added 0.41 point less to the annual CPI inflation compared to April, yet remained the pioneering contributor to consumer inflation with 3.10 points.

So just as they get a little relief from food price inflation they find energy prices rising.If we move to another basic necessity which is water the picture is even worse.

municipal water prices remained on the rise and the annual inflation in this sub-group maintained its high course with 17 percent.

There is also not much of a get-out clause for the central bank in core inflation.

Annual core goods inflation increased by 0.83 points to 5.88 percent.

Also the inflationary trend is noticeable in producer prices which have been falling heavily in many parts of the world.

Domestic producer prices rose by 1.11 percent month-on-month and the group’s annual inflation climbed to 6.52 percent in May.

Interest-Rates

These are as shown below.

One-week repo rate at 7.5 percent

This provides plenty of food for thought. For example the nearby Euro area has a headline interest-rate of -0.2% which provides a difference of 7.7% in return over a year. Such a size of gap indicates the exchange-rate problem as investors need quite margin and remember the Euro itself has fallen overall in recent times. If we move to the domestic position then I do have an issue with the TCMB saying this.

tight monetary policy stance

World inflationary trends have turned and even before today’s developments the Turkish Lira had been falling so policy was in fact loose. Also the TCMB has been cutting interest-rates since the recent peak of 10% in January 2014 with the latest cut from 7.75% happening on the 21st of January. Mind you the TCMB can do a good line in goobledygook.

The ongoing cautious monetary policy along with prudent fiscal and macroprudential policies…..

Economic Output

We get to the truth of why the TCMB has cut interest-rates when we look at the trends here which show a slowing from the average of more like 4 to 5%.. If we look at the GDP numbers we see that inflation was a big problem in 2014 too.

GDP at constant prices. increased by 2.6% in the fourth quarter of 2014 and reached to 32 billion 104 million Turkish Liras. GDP at current prices increased by 9.8% in the fourth quarter of 2014 and reached to 446 billion 366 million Turkish Liras.

So 7.2% inflation on this measure but what is happening now?

This morning’s industrial production numbers were flat on a monthly basis but did show a response to a lower currency when compared to 2014.

Calendar adjusted industrial production increased by 3.8% compared with the same month last year.

However the Markit business surveys show a completely different picture.

Turkish goods producers cut output in May, continuing the trend shown every month in 2015 so far……. New orders fell for the fifth month running, albeit at the slowest rate over this period, with the same trend evident for new export orders.

Retail Sales

Today’s update suggests that there is growth to be found here too.

Seasonal and calendar adjusted retail sales volume with constant prices increased by 0.3% in April 2015 compared with the previous month……..Calendar adjusted retail sales volume with constant prices increased by 3.8% in April 2015 compared with the same month of previous year.

Trade is a problem

You might think that the tourism industry would mean that Turkey would have a strong trade position whereas in fact the situation is troubled. From Turkish Statistics.

in April 2015; exports were 13 billion 392 million dollars with a 0.2% increase and imports were 18 billion 358 million dollars with a 11.1% decrease compared with April 2014.

So we see the impact of the fact that imports are more expensive although there was very little pick-up in exports. Actually April flattered with its 0.2% increase as so far in 2015 Turkish exports have fallen by 5.7%.

This means that Turkey has exported just over 50 billion Lira of goods but imported some 70 billion Lira.

Comment

There is much to consider here and something of a reminder. After all high inflation combined with trade issues have been a regular feature of the British economic landscape. They did not do us any good with the word stagflation appearing rather regularly. One feature of that period was interest-rate rises as a policy response and as an emergency measure the TCMB may be considering that although for it this would represent an embarassing about turn. It could also intervene to bolster the exchange-rate but when it tried that in early 2014 funds flowed out very quickly.

So we have an economy which has chosen economic growth as its policy aim and it has ignored inflation and trade issues. What does it do if growth slows now? A weak currency is not the best environment for an interest-rate cut. Also ominous is the fact that Turkey was receiving international praise a couple of years ago which is usually a harbinger of trouble. World Bank Group President Jim Yong Kim from October 2013.

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

Number Crunching

Today’s example comes from the UK CBI (Confederation of British Industry) which feels that it can predict economic growth to an accuracy of  0.1%!

The UK’s leading business group is forecasting 2.4% growth for 2015 and 2.5% in 2016. That represents a slight downgrade compared with February’s forecast of 2.7% and 2.6% respectively.