Monday, February 14, 2011

Weekly Hurriyet Column: Saint Valentine’s Day Massacre

Below is  my Hurriyet Daily News & Economic Review column for this week, which you can also read at the Daily News website. As for the title, I am it is history rather than movies this week...

I will have an addendum later today or tomorrow, especially on detailing how you could take advantage of my lira scenario, but I should out front that I found out today that my view is not as contrarian as I had thought: Among the several pieces I read today on tomorrow's CBT MPC meeting, J.P. Morgan's is the most similar to my views. I like their argument on extra liquidity, but although I did not verify this, it seems their measure only considers daily stock of OMOs. They should have also penciled in the unsterilized FX buying. 

As for the implications of a rate cut tomorrow: Master YesilAODA (I am a padawan compared to him, especially in market matters, and his last name means GreenRoom, so the Yoda comparison isn't that bad after all) also thinks that there will be a massacre of the lira if the CBT cuts rates tomorrow, as he highlights at the end of his Finansonline article today (in Turkish).

That's all I have to say until the addendum, so on to the column:

Technically, it would not be Saint Valentine’s Day massacre, unless you have decided to inhabit the uninhabited Baker and Howland islands.

Other than these two atolls fourteen hours behind Turkey, the Central Bank of Turkey’s, or CBT’s, rate decision will come the day after Saint Valentine’s Day. Moreover, the lira’s massacre would have materialized only if the CBT were to cut the policy rate again and signal of more cuts to come.

The Bank is unlikely to follow that route, as the conditions that justified its foray into the unconventional policy mix of cutting the policy rate and increasing required reserve ratios have changed significantly. For one thing, the “wall of money” into emerging markets that started with the Fed’s Quantitative Easing II, and prompted the CBT to act, is slowing down sharply.

This means that capital inflows are likely to become selective, and I would expect to see some differentiation between countries with current account deficits and surpluses. The lira, the currency of the archetypical deficit country, is likely to feel some pressure.

Besides, the Bank has been quite successful in weakening the currency, although I am not sure it is the result of its policies, or what I deem as constructive ambiguity, i.e. confusing markets on the direction of monetary policy. The lira has depreciated around 10 percent against the dollar-euro basket since November. To try to weaken it more by cutting the policy rate could lead to a sharp correction.

Inflation does not paint a rosy picture, either, even though it is at a historical low. Even without reversing base effects, the inflation outlook is quite challenging, thanks to the possibility of pass-through from import and producer prices as well as the upward trend in global food and energy prices. In addition, demand pressures are building up, as the latest industrial production figures confirm.

Perennial optimists still believe that the government will support the CBT with tight fiscal policy. The January budget, to be released on the same day as the rate decision, could give them false hopes, if last week’s cash budget is any guide. But counting on fiscal policy before the June elections, especially given that the ruling AKP is aiming for constitutional majority, would be unrealistic.

Adding all this together, you realize that it would make sense for the Bank to put a stop to the rate cuts. However, despite some claims otherwise, the full effect of the policies on credit has yet to be felt. For one thing, the Bank’s latest reserve hikes won’t be in effect until Friday. Besides, when taken in conjunction with the rate cuts, the net effect of monetary policy so far is only a slight tightening.

Without additional support from the banking regulator or the government, reserve hikes of at least a couple of more percent would be needed for loans to decrease meaningfully, especially if the Bank would continue with providing liquidity through auctions and unsterilized foreign currency interventions. The CBT would then probably start hiking rates during the second half of the year.

Therefore, without ruling out some more weakness in the short-term, the lira’s prospects look good over the longer run. Interestingly enough, markets have not fully priced in this policy shift at the moment. Longer-maturity dollar-lira bets look especially attractive, and several, like dual currency deposits, are accessible to the average investor. In fact, I will have got some as you read these lines.

But that doesn’t mean you should, too: Doing exactly the opposite of what economists are saying, especially of those with little market-savvy like your friendly neighborhood economist, is often a great strategy.

Emre Deliveli is a freelance consultant and columnist for Hurriyet Daily News & Economic Review and Forbes as well as a contributor to Roubini Global Economics. Read his economics blog at


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