The embattled Turkish lira (TRY) rallied to a one-week high and government bond yields were on track for the biggest ever weekly fall on September 7 as speculation mounted that the Central Bank of the Republic of Turkey (CBRT) will raise interest rates next week to address the country’s currency crisis.
However, analysts were treading carefully in assessing whether the central bank will do what it takes to get monetary policy back on course, given the populist Erdogan administration’s distaste for interest rate hikes.
“Overall, we think that the CBRT is likely to disappoint next week,” Jason Tuvey at Capital Economics wrote in a September 6 note to investors. “The central bank’s independence has been completely undermined. If the government were willing to allow the CBRT to raise interest rates aggressively, it would surely have signed off on it many weeks (perhaps months) ago. That would have helped to at least contain the recent currency crisis.”
Timothy Ash at BlueBay Asset Management, meanwhile, sent a “message to the CBRT”, saying: “Turkish assets are only rallying as they think you will do the right thing and raise rates on September 13 [at the scheduled policy meeting]. Don't misread what is happening—if you screw up again and don't hike, you will be back in the same place at mid-August... perhaps worse. Wake up and do the right thing.”
Strong-arming the CBRT
Tuvey added that while there have been few comments from President Recep Tayyip Erdogan in recent days, “it’s highly unlikely that his antipathy towards high interest rates has dissipated. He will no doubt strong-arm the CBRT to undertake only a limited rate rise. For our part, we have pencilled in a 200 bp in the CBRT’s policy rates. If that transpires, the lira is likely to come under renewed downward pressure.”
There have been several calls for the central bank to opt for a radical rate hike of as much as 1,000 bp to show it means business and Tuvey said that although the regulator has “all but confirmed that it will raise interest rates at next week’s MPC meeting” an increase of 350-400 bp would seem to be “the bare minimum that will be needed to soothe investors”. However, he added that “pressure from the government means we think that the rate hike will be smaller, at around 200bp”.
JPMorgan Chase & Co. has pencilled in a tightening of 500 bp and says the rate-setters could deliver that in one go or over two meetings.
While the TRY strengthened 2.6% d/d to 6.4047 against the dollar by around 18:20 local time on September 7 (that compares to the all-time low of 7.24 recorded in early August), government bonds rallied in thin liquidity, with yields on 10-year debt falling as much as 62 bp to a one-month low of 19.55%.
That took the move this week to 2.21 percentage points, the biggest weekly drop on record, according to data compiled by Bloomberg.
Data released on September showed the tanking lira sent Turkish inflation to a 15-year high of 17.9% y/y in August—more than three times the CBRT’s target—and, as the effects of the currency crisis feed through, it is likely to rise even further in coming months, according to the market consensus.
Tuvey said that one way of illustrating how much monetary policy needs to tighten is to consider how far real interest rates—that is, nominal interest rates deflated by inflation—need to rise.
“The experience from other EMs is that, on average, real interest rates tend to rise by 10.5%-pts around the time of currency crises,” said Tuvey. “Hikes to nominal interest rates earlier in the year, coupled with more recent monetary tightening via the interest rate corridor, have pushed real interest rates in Turkey up by around 400bp over the past few months. But they remain in negative territory. And a further nominal interest rate hike of around 600bp would be needed simply to bring the change in Turkish real interest rates into line with the average during previous EM crises.”
Analysts polled by Bloomberg were at the time of writing split between an aggressive rate hike of up to 750bp and no change, Tuvey said.
Assessing the bond buying, Emre Alcelik, a broker at Continental Capital Markets in Nyon, Switzerland, told the news agency: “There are decent buyers across the curve.” The buying was being spurred by the central bank’s
signal that it could raise rates, and was being compounded by a lack of trading volumes. “Other than primary-dealer bonds on the
exchange, it is not easy to find liquidity,” he added.
Combined outflows from Turkish equities and treasuries in the first eight months of this year climbed to $1.3bn, the highest figure since 2015.