Turkish assets have of late been gaining—or at least not collapsing—even though President Recep Tayyip Erdogan has been deploying his by now well-worn strategy of sparking consecutive headline-grabbing shocks to ensure that everyone forgets his political defeats, the latest being his humiliating loss in the Istanbul revote at the end of June.
The main driver behind the solidity displayed by Turkish assets is seen as the full control exercised by the authoritarian government over the markets.
The Turkish lira (TRY) remains under the control of officials via the state banks that are monitoring the FX market on a 24/7 basis—they curb any sign of an upside move and exert pressure on the exchange rate when there is any downside potential.
The Treasury’s latest eurobond sale, for $2.25bn, fuelled the government’s arsenal in the lira battle, while the central bank taps local lenders’ FX deposits at any time it sees fit.
The currency regime in Turkey is currently defined as a ‘dirty float’.
The Borsa Istanbul is also seemingly much under the control of the so-called ‘The Dude’, a mysterious algorithmic trader who has worked in favour of Erdogan since the beginning of 2016.
The domestic bond markets have also been systematically scrapped since last November after the government spooked foreign investors by manipulating interest rates at debt auctions. Moreover, the banks’ deposit and loan rates are essentially imposed.
From the domestic perspective, it is not really possible to define Turkey as a free and open market anymore, but there again Donald Trump’s is doing pretty well undermining such concepts with his heavy, public pressure on the Fed and nickname of ‘Tariff Man’.
The present global bond market mood has gone ultra-positive based on strengthening expectations for a renewed easing cycle from the Fed. If the cycle proves to be like previous ones, enough capital to finance populists and dictators everywhere will rain down.
On the risk front, plenty of ugliness could be on the way with a worsening trade war, a global recession, growing geopolitical tensions and bubbling asset prices. But markets for the most part remain blithe, with only the shrewder analysts noting, to toy with a phrase from Keynes, that “we are all dead in the medium run”.
Global finance outlets find it hard to acknowledge the current, brewing conditions; they just keep doing what they did in the good old days when they had some teeth.
“A serious meltdown in the lira last summer started on July 24, when the central bank shocked financial markets by keeping interest rates on hold, confounding expectations of a hike,” Ziad Daoud of Bloomberg wrote on July 18 in an op-ed entitled “TURKEY PREVIEW: 300-bp Rate Cut Could Spark Lira Crisis Redux”.
It should be observed that the lira market was still a relatively open and free market last summer, and Erdogan was yet to show the door to foreign investors by temporarily shutting down the offshore lira swap market in London.
Bloomberg forecasts that the central bank will cut its main policy rate by 300bp to 21% at its next monetary policy committee (MPC) meeting to be held on July 25, although it estimates that the financial markets are only pricing in a cut of 200-250 bp.
As the central bank long ago lost its independence—in a coup de grace, Erdogan last week fired its governor by presidential decree and installed his new man, who will be expected to do his bidding and cut when told—and, as a result, its relationship with logic and econometrics , Bloomberg’s methodology in concluding that a 300bp rate cut should be pencilled in amounted to a perfect parable in understanding how market commentators produce such forecasts.
As an initial step, Bloomberg takes Erdogan’s official inflation data along with his monetary commentary in earnest.
“The president sees inflation falling to single digits by year-end and expects interest rates to be cut in ‘a serious manner.’ Let’s assume he’s aiming for 9% inflation in December,” Daoud wrote, adding: “The newly-appointed governor, Murat Uysal, vowed to preserve ‘a reasonable rate of real return’ for investors. Let’s assume this means 3% of real interest rates.”
In looking to define “bold assumption”, the Oxford English Dictionary could do worse than offer up Bloomberg’s assumptions as an example.
Based on those assumptions, Bloomberg reaches the conclusion that “the policy rate should be 12% at year-end, about 1,200 bps lower than current levels”.
With only four MPC meetings remaining this year, Erdogan’s view implies 300bp of cuts at each meeting starting with next week’s, according to Bloomberg.
Ignoring the financial deficit
Alongside falling inflation, another positive argument for the Turkish macro picture suggests that Turkey’s shrinking current account deficit reduces the country’s economic vulnerabilities. This argument holds only when the financial deficit in the balance of payments caused by debt repayments and capital outflows is ignored.
Even if the ongoing collapse of the real economy is added to the picture, the key macroeconomic factors do not seem to make an impact on Turkish market sentiment as long as Erdogan has some USD to sell in exchange for TRY.
Where foreign policy risks are concerned, Erdogan has also managed to frame his game. There is currently far too much noise in the foreign media about Turkey in comparison to little action. Erdogan, with his skill for angry, populist rhetoric, has benefited from this scheme for a long time.
Also on July 18, a “harsh” op-ed entitled “Turkey Has Abandoned the West. Good Riddance” by Bloomberg’s “Editorial Board” was published.
The arguments set down, starting from the headline, were pure orientalist fable, reminding one of Marco Polo.
Even if we overlook how Bloomberg still takes it as a given that some genuine strong alliance called “the West” still exists despite the unilateralist Trump’s tenure in the White House, a more realistic proposition could be something like “Erdogan, indulged and built by the West, has abandoned Turkey. But Turkish citizens have no way of wishing him good riddance”.
And, “the West” as referred to in the latter argument, refers to the times when a real sturdy alliance taking that name existed and was bombing Iraq and Syria.
The age-old stories of Third World dictators being established but later bombed by the West never go stale. Nor do the tales of Western support for ‘just’ military coups hailed as delivering democracies (with the definition kept deliberately loose). So there’s no need to spend any more time on who constructed Erdogan and who still finances him—but the Bloomberg Editorial Board’s perspective shows that plentiful folk in the West still have no appetite for facing up to what’s really going on.
“For the past few years, as Turkish President Recep Tayyip Erdogan has railed ever more belligerently against the U.S., Europe and NATO, Washington’s foreign-policy establishment has argued for patience. Erdogan’s fusillades, mostly intended for domestic consumption, were thought to be a small inconvenience—certainly not enough for the West to abandon Turkey,” Bloomberg Editors also wrote.
According to said editors, there is a “foreign-policy establishment in Washington” and they also “think”.
If the establishment in question had spent a little more time on “understanding” before “thinking”, they may have become aware why yelling at the US sells.
Unlike the Western media and the purported Washington establishment, Erdogan is aware that “the West” has collapsed and he has built his very own banana republic thanks to its incomprehension and ongoing financing.
Bloomberg Editors have also written a series of pieces advising the EU, the US and Nato on how to deal with Erdogan. But let’s just be a little bit more honest here. Let’s not fool people. "The West" either wants a tinpot dictator in Turkey or it has no idea about what it has done since the beginning of the 2000s.
Erdogan’s share in Germany’s total arms exports jumped to 60% in January-April from one-third last year with deliveries this year mainly comprising of maritime goods, including six submarines. And German Defence Minister Ursula von der Leyen was this week elected as the President of the European Council.
Jens Stoltenberg, the secretary general of Nato, reiterated on July 18 that Turkey remains an important ally, Bloomberg reported, as Trump groused about no longer being able to sell Erdogan billions of dollars of F-35 fighter jets because he’d crossed the Rubicon in buying Russian S-400 missile defence systems.
Attempting to squeeze more out of the distraction, Erdogan said that the S-400 deliveries would be completed by April 2020.
All in all, Erdogan is still able to keep the markets and "the West" under control but the ongoing wretched deterioration in the Turkish real economy does keep digging his prospective grave at home.
His continuous efforts to buy time on all fronts fuel rumours that he is getting ready for snap elections. But attributing some certain meaning to Erdogan’s actions usually ends up as a desperate folly, with the Istanbul revote fiasco that put egg all over his face, despite grim warnings that he would certainly steal the vote, a prize example of that perilous pursuit. Erdogan does what he knows, or perhaps, we should say, what he can, and there’s truly nothing left to control him. Whether he will trip over himself and meet a sorry end is really the only question.
Meanwhile, the economic storm clouds that could trigger a fateful action once more gather over Turkey. Officials only have enough ammunition and devilish schemes to hold off economic realities for so long. There is no rigid forecast discussed on the markets at the moment but many who foresee an upcoming collapse talk of September. But this is the Turkish darkness we’re talking about. There’s no guarantee it won’t happen tomorrow.