No hike but enhanced forward guidance from the CBRT, an opportunity missed.

Summary:

  1. CBRT kept rates unchanged, against my expectations of a 100bps hike. The statement included some strong language on their willingness to maintain tight monetary policy and to hike if needed. The market reaction to this enhanced forward guidance was strong, with TRY rallying.
  2. Foreign inflows stopped in the week ended 15th January, however the CBRT’s stronger commitments to tight monetary policy in their statement on Thursday should attract foreign investors to Turkey.
  3. The Treasury came to the market with $3.5bn of Eurobonds, $1.75bn of 5yr and $1.75bn of 10yr. The 10yr yield was in line with the last Eurobond issue in November, however the 5yr was issued at a tighter yield and spread than the previous issue in October.
  4. Erdogan on Friday once more said that he was against high interest rates. Twice in one week is worrying, however for now this doesn’t appear to be an indicator of an upcoming change in Turkish monetary policy.
  5. Vakifbank launched a loan programme for production, not as lenient as the credit impulse in the summer, but shows the government still favours credit expansion to reflate the economy.

CBRT kept rates unchanged and enhanced forward guidance. I expect the first rate cuts to come in Q4 this year at the earliest.

At their first meeting in 2021 on Thursday, the CBRT kept rates unchanged at 17%. I had been expecting a 100bps rate hike as the CBRT sought to continue regaining their credibility by delivering an unnecessary monetary tightening step. The CBRT also enhanced their statement to include the phrase ‘Additional monetary tightening will be delivered if need’, while also stating that the indicators they will be looking at are ‘indicators for the underlying trend of inflation and pricing behaviour, diffusion indices, demand and cost factors, and inflation expectations’. These changes to the statement are an enhancement of the forward guidance that they have been providing regarding their commitment to keep monetary policy tight in order to bring inflation down in Turkey.

Despite the lack of hike, the market reaction to the statement was positive, with USDTRY down 1% on the day, before a rebound on Friday. In addition, the rates curve moved lower, partly as a reflection of lower spot and partly as risk premium was taken out of the back-end of the curve in response to the tougher forward guidance revealed by the CBRT.

TRY was the third best performing world currency vs USD on a total return basis last week

Source: Bloomberg

There are still a number of challenges facing the CBRT as they seek to re-anchor inflation expectations lower in order to try and bring down the inflationary bias within the Turkish economy. There is widespread distrust of Turkstat CPI figures, with independent estimates putting ‘real’ CPI at 30%+, with this distrust making it harder for the CBRT to re-anchor inflation expectations and stop pro-inflationary behaviour from corporates and individuals.

Additionally, convincing local savers to convert their hard currency and gold savings back into Turkish lira is difficult for the CBRT. Given the widespread distrust of official CPI numbers and repeated experiences of currency devaluation under the Erdogan government, Turkish savers continue to hold a large proportion (over 50% of deposits) in hard currencies and gold as a hedge against economic mismanagement. At the moment, the negative carry on these positions is around 17%, given that banks are offering deposit rates of around 18% and there is a 5% deposit income tax on any TRY deposits. While this is painful and might be enough to convince savers not to add to their hard currency savings, a higher rate and more punitive negative carry would be needed to convince savers to convert large amounts of their savings back into Turkish lira.

Deposit rates are just above the repo rate, and at or below the repo rate after the 5% deposit interest tax

Source: www.enuygun.com

Foreign inflows to Turkish markets slowed in the week ended 15th January, likely taking a break before the CBRT meeting. The enhanced forward guidance from the CBRT should lead these to pickup again.

Inflows to TurkGBs and BIST equities slowed from $777m the week ended 8th January to $13m for the week ended 15th January. This represents a significant slowdown from the pace we’ve been seeing since November as foreign investors have returned to Turkish markets, and pulls the rolling monthly inflow number down to $1.009bn from $2.902bn the week before. I suspect this pause was likely as a result of the upcoming CBRT meeting, as investors waited to see whether the CBRT would reiterate their tight monetary policy stance, or even hike.

Given the story currently in Turkey, with orthodox monetary policy likely to be in place for the foreseeable future, high carry in fixed income products, and cheap valuations in equities, I expect Turkish asset markets to return to seeing strong inflows in the near future.

Foreign inflows to Turkish markets slowed last week, bringing down the rolling monthly inflow number

Source: Bloomberg

Treasury issued $3.5bn of Eurobonds, $1.75bn of 5yr and $1.75bn of 10yr. This represents about 1/3rd of the Eurobond issuance scheduled for this year.

The Turkish Treasury came to market with a two part issue on Tuesday, issuing $1.75bn of 5yr bonds and $1.75bn of 10yr bonds. The 10yr bond was issued broadly in line with the previous issue in November, however the yield on the 5yr issue was significantly lower than the last issue. The 5yr issue in October had a yield of 6.40% vs a yield of 4.9% for this issue, with the spread over Treasuries also declining from +609bps for the last issue to +445bps for this one. This significant spread tightening is a measure of the return in confidence to Turkish markets since the new economic team was installed in November. In addition, the order book was the largest for any Eurobond issue by the Turkish government, with total demand of $15bn.

The Turkish Treasury are known as canny issues, picking good times to issue and having a good feel for the markets. The fact this issue represented 1/3rd of the scheduled Eurobond issuance and was executed at the beginning of the year during positive market conditions is a definite positive for the Treasury, and is indicative of good planning on their part.

Erdogan made brief comments on Friday that he is unhappy with high rates. While still too early to say that these comments presage a change in Turkish monetary policy, having these comments a week after the last comments is a negative.

More comments from Erdogan this Friday, saying he is ‘absolutely’ against high interest rates, and that he ‘[doesn’t] believe my country can develop with high interest rates’. These comments were made to a group of businesspeople, like the comments last Friday, so there does seem to be an element of political theatre to all this. Erdogan is a master of messaging, and these comments most likely represent an example of him providing a political message to the business world. Turkish businesses were inundated with cheap loans over the past year, and will have been unhappy about the withdrawal of liquidity that the new economic team have presided over. It’s therefore reasonable, in my view, to take these comments as attempts by Erdogan to curry favour with the business community, rather than indications that he will soon demand easier monetary policy from the CBRT.

With that being said, these comments from Erdogan will make the CBRT’s job harder, with questions about their credibility lingering below the surface following Erdogan’s previous moves to force easier Turkish monetary policy. I think the CBRT missed a chance on Thursday to dispel these credibility issues with a rate hike, and these comments will have added to any perceived credibility gap.

Looking at Turkish economic reality also gives the picture that Turkey cannot engage in easy monetary policy at this time. True reserves at the CBRT stand at around -$30bn, an improvement from a low of around -$50bn, but still not enough ammo to defend against currency depreciation if Turkish monetary policy is eased. In addition, international investors and local savers remain wary of the CBRT’s policy credibility, and any move that puts this into question will cause foreign outflows to resume and local savers to renew their dollarisation.

Vakifbank, a large state bank, have launched a $5.4bn package of TLREF-linked loans to promote production in Turkey. While the loans are linked to TLREF, they have a cap of 17.75%.

Vakifbank have launched a new loan package of $5.4bn for Turkish manufacturers and exporters to support the Turkish economy during the pandemic. These loans are linked to TLREF, which is the rate the TRY OIS market is fixed against. The loans have a cap of 17.75% and they have no floor, such that if rates fall this fall will be passed on to borrowers, and borrowers will only pay higher rates if rates rise to 17.75%, after which the bank will wear the difference. This harks back to the credit impulse pumped into the economy last year to try and stoke domestic production during the pandemic, and shows that the Turkish government continues to favour credit expansion to inflate the economy. I will be looking out for any other signs that Vakif and the other state banks (Halk and Ziraat) are moving to extend more credit at relatively favourable rates, as this would be a key factor in the outlook for the lira becoming more bearish.

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