The Kapali Carsi

Markets Getting Ahead of the Central Bank of Turkey

One of the leading Turkish economy themes of this past week was the large decline in government bond yields.

Here’s the intro. to my latest Hurriyet Daily News column, where I discuss the factors behind the sharp drop in Turkish government bond rates last week, and whether that trend will continue, accompanied by some lira weakness. You can read the whole thing at the HDN website, but I have a few additional points to make.

First, part of my argument that the Central Bank will not ease further is based on the fact that data are not hinting to a slowdown. But they are not pointing towards a marked acceleration in growth, either. In fact, as I argue in my previous blog post, which I wrote as complement to the HDN column, I argue that growth signals are very much mixed. In this respect, it will be important to watch real sector indicators, such as today’s industrial production, for the next few weeks.

Then, there is the capital account. Nomura economist Olgay Buyukkayali does not agree with me that the external financing picture is risky. But he arrives at the same conclusion, that we should not expect more easing, by arguing that the current account is not a priority for the Central Bank anymore. No wonder economics and economists annoy people:) In any case, Wednesday’s Balance of Payments data will be important to watch, as we will be able to see whether the downward trend in the capital to current account ratio is continuing. By the way, Olgay makes a similar argument as my main theme in that same note by highlighting that markets are ahead of the curve.

On inflation, I should note that while there is a downward trend in core inflation, it is still too high for the Bank’s 5 percent target.

On a different note, I could not grasp how the possibility of a downward revision to the Bank’s end-year inflation forecast led markets to believe more easing was in the pipeline. My thinking is exactly the opposite: If the Bank lowered its forecast, I’d think they were trying to bring their end-year figure closer to the target rather than use the opportunity to ease rates. That’s what Basci emphasized on Friday as well…

Finally, it is important to note that global risk sentiment played a role in last week’s sharp fall in rates as well, as results of the EU Leaders’ Summit exceeded expectations. You can see this from the upward move in safe-haven bond yields, whereas Spanish and Italian rates fell.

While this trend reversed at the end of the week, global developments directly affect Turkey’s heterodox monetary policy as well. Here’s how Murat Ucer of GlobalSource Partners (and Turkey Data Monitor) puts it in their latest quarterly report:

when times are ‘good’, i.e. when it is up to the Bank to chose its monetary policy stance, policy is likely to be accommodative, with the liquidity being provided at a rate as low as feasible – albeit, cautiously so. When times are ‘bad’, i.e. when monetary policy is constrained by lack of inflows and F/X market pressures emerge as a result, the Bank moves to a high rate/tight liquidity regime, out of choice, in order to curb further lira weakness

Last week was definitely good times:). Murat goes on to make arguments similar to those in my column by noting that inflation dynamics and the external financing picture prevent the Bank from easing aggressively. He does not expect money market rates to ease below the 8-9 percent range.

One simplification I do in the column is to talk about just one government bond rate, the benchmark. But the dynamics of the short-end (the 2-year benchmark) versus the long-end are quite interesting as well. This yield-curve dynamic quite outside the topic of the column, so I won’t delve into it here. I am merely referring the interested reader to Nomura and Citi’s recent notes touching upon this topic.

The same Citi note also adopts a different methodology altogether to see if the benchmark has more room to go: They look at “the time-varying relationship between the benchmark bond yield and its drivers” and find that, “after controlling for global risk appetite and oil prices, domestic liquidity conditions have become more important in affecting the 2-yr bond yield.” Note that this is very similar to Murat’s good/bad times argument I outlined above. Interestingly, Citi economists also find that “the link between the currency and the benchmark bond yield has weakened recently”.  This may be why the lira held up rather well last week.

Finally, the proper way to end this post is by mentioning pr0-government daily Sabah and its illustrious economy editor. In his editorial on Friday (unfortunately in Turkish, you don’t know what you are missing, but there isn’t much I can do about that), he argues that the “interest rate lobby” is now trying to lower interest rates. They will then sell their Turkish government bonds at a premium and buy FX cheaply. This makes sense- except that the lira would weaken (and FX would become more expensive) as a result of lower rates. Uppppsssss, but I already knew economics was not his forte. But at least he should decide what he wants the lobby to do: Because after accusing them to artificially try to raise rates for a long time, now he is blaming them for asking for lower rates. So he should really make up his mind:)…

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