26 Juli 2018
The Turkish Central Bank (CBRT) disappointingly left the one-week repo rate unchanged at 17.75 per cent during their scheduled MPC meeting. This was a major policy mistake from the Turks and a missed opportunity to build on the credibility they gained with +500 basis points (bps) of tightening delivered during Q2. The markets had expected a +100 bps rate hike and this was viewed as the absolute minimum required to appease continued investor fears about the country’s outlook. As a result, investors punished the Turkish currency.
Note: Data at 5 minute intervals. Source: Eikon, 24 July 2018
Today’s (24 July 2018) meeting was the first scheduled MPC gathering since President Erdogan’s controversial cabinet reshuffle following the 24 June elections, where his son-in-law Berat Albayrak was appointed minister of the newly combined Treasury and Finance departments. That development, along with the demotion of market favourite Mehmet Simsek, prompted considerable nervousness from investors around Central Bank independence, policy pragmatism, and the outlook for Turkey’s fiscal balances ahead of local elections in March 2019.
With today’s inaction, question marks clearly remain around Turkey’s commitment to reducing inflation expectations on a sustainable basis. Following the interest rate hikes delivered during Q2, Turkish growth is likely to cool moderately over the next six months and this may improve the very short-term outlook for Turkey’s alarmingly wide current account deficit. However, it remains to be seen if Turkey can push towards a more sustainable growth path compared to the overheating witnessed over the past 12 months.
Following today’s developments, we remain cautious on the lira and Turkish local currency bonds and expect further additional risk premium to now be priced into the market. Furthermore, the outlook for emerging markets (EM) more broadly remains clouded by exogenous factors as we head into August, typically a challenging month for all risk assets.
The US Fed will continue to hike rates while also reducing the size of their balance sheet and this significant liquidity withdrawal will remain a headwind for EM. In our view, the balance of risks are also skewed towards a firmer US dollar driven by interest rate and growth differentials between the US and the rest of the world. Additionally, the continued tit-for-tat trade protectionist rhetoric from the US has the potential to develop into a major headwind for EM growth given the sensitivity of the asset class to global trade. EM rarely trades well when the US dollar is appreciating, or when the Chinese renminbi is weakening, and at present we are faced with both. In our view all of these risks in aggregate warrant higher risk premium across EM, including Turkish local markets.
We would only change our opinion on the bearish EM trajectory if we saw evidence of either the Fed backtracking from its policy tightening autopilot, a dampening of global trade war rhetoric, a sharp rebound in EM growth momentum or a major new fiscal stimulus from China.
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