Monday, February 9, 2009

Weekly Hurriyet Column: Deceived by the Winter Sun

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. In retrospect, I noticed that I have chosen a title very similar to the previous week's. What a bore I am:)....More interestingly, two and a half months after this column, I stand behind my necessary conditions for a US recovery- unfortunately, the US economy has not really gained much ground in the past 70-odd days on these.

One of the first things you learn living in New England is not to get deceived by the bright winter sunshine, as it usually goes in hand with temperatures in the negative Fahrenheit territory.

Optimism abroad

Lately, there are increasing signs abroad that the worst of the crisis has passed, to such an extent that even the dismal US non-farm payrolls data was largely ignored. While stimulus packages around the world are providing the moral motivation, the uptick in several purchasing manager indices is leading hopes that the global economy has bottomed out. In a similarly Pollyannaish manner, the recent rise in the Baltic Dry Index, an assessment of the price of moving major raw materials by sea, is being interpreted as a sign that trade credit is finally stirring.

Although I will not attempt a global economic treatise here, I find it hard to believe that the US will start recovering before inventories are being worked down, household savings rise or house prices stabilize and banks get rid of their toxic assets one way (a government insurance scheme) or another (a bad bank solution). Unfortunately, none of these three necessary conditions is close to being satisfied yet.

Optimism at home

While I hit bull’s eye with my inflation forecast last week, this is one prediction I would have preferred to be dead wrong in. It is true that the 0.29% monthly rise, although above expectations, was the best January figure ever, but despite the unanimous laying of the guilt solely on food inflation, I am worryingly seeing early signs of an exchange rate passthrough. Similarly, while the muted producer inflation and decline in manufacturing prices hint to limited cost-led pressures, it seems that –as noted by the Central Bank- the fall in oil prices has equalized foreign currency movements. Inflation is likely to be a tug-of-war between domestic demand-dependent service goods and tradeables in the coming months.

The recent rise in consumer confidence has been another confidence-booster. However, part of the increase is reflecting a correction from the sharp falls earlier. Moreover, a quick statistical analysis reveals that asset prices (especially USDTRY and the ISE index) and political shocks go a long way in explaining consumer confidence. Therefore, while it is definitely a positive development, the rise in the fragile consumer confidence should not lead to rejoicing yet.

As both inflation and consumer confidence seem to hinge on it, it is natural to dig deeper into the exchange rate. The lira has held remarkably well in the past few weeks despite the rout in many emerging markets, even though the government, with the delayed IMF deal, the Davos incident and another round of Ergenekon, was doing its best to have the currency move in tandem with peers. Given that Turkey has led the pack in the reduction in emerging market-dedicated funds’ net exposure, locals seem to be behind the currency’s relative strength, as foreign currency deposits have declined by around USD 4bn this year. This is all fine, unless locals decide to wait out for further lira weakness, so the current situation is definitely not rock-solid.

Another interesting development is the recent uptick in parts of consumer credit, which may also be due to restructuring of credit card debt. Any short-term movements in commercial credit should similarly be taken with a grain of salt, especially as there is no change in the fundamentals restraining loan supply and demand. In this respect, the 117% debt-rollover in the past week’s auctions should be a reminder of the risk of crowding out.

The recent data seem to have led many to a winter jog. They might end up catching a bad cold.

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