I believe underlying the decisions the Central Bank has or has not taken it is this feeling that the current international tensions will prove temporary. Are they really?
I previously expressed that the prediction that dollar will hit down to 1.92 TL by the end of the year is based on the feeling that the current international tensions will prove temporary. I believe it is this feeling that underlying the decisions the Central Bank has or has not taken. Are they really temporary?
1 - Such sharp increases in interest and exchange rates were observed in the past, like in 2004, 2006, and finally in the second half of 2011. These were not permanent and faded away soon.
2- This time it is both similar and different: similar because the main cause of the hikes is the expectation that the Federal Reserve (FED) will introduce monetary tightening. It is different because FED’s plan will be more comprehensive and longer-term.
3- As a first step to be taken in a few months, the FED will gradually taper additional liquidity amount injected to the markets by bond purchases starting in the fall of 2012 (in the context of the quantitative easing program). It will eventually stop bond purchases probably by the mid-2014. There were no such quantitative easing and tapering operations back in 2004 and 2006.
4- As a second step, it will raise the policy rate, the federal bond rate. This projection does not affect markets currently as the FED will launch it only by the end of 2015, when it is confident that unemployment rate will decrease to 6 percent and below. Currently the bond rate is lower than the lowest rate observed before the tightening operations in 2004 and 2006. Therefore, it will increase further before it cut back to normal.
5 – Third, the FED will scale down its balance sheet soon after it increases the bond rate. Different from the cases in 2004 and 2006, the FED’s balance sheet has more than tripled since 2007. To scale down its budget, it will stop reinvesting mortgage-backed assets and treasury securities it had bought in the aftermaths of the global crisis to trigger the credit market. No such operation was carried out in 2004 or 2006.
6 –Current exchange rate increases in emerging market economies is related to the first step the FED is expected to take. If the FED’s strategy was limited to this first step, we would expect that the current upwards movement in exchange and interest rates would eventually stop and be reversed at some degree. If so, the current trends could have been deemed temporary.
7- Probably by the mid-2014, however, the following steps will rise to the agenda. Therefore, even if the markets cool down when it becomes known when the FED will launch and complete the first step of the operation, the tension will escalate back again on the basis of the interest rate operation.
8- Note that currently interest on 10-year US treasury bonds is around 2.8 percent. If the inflation in the US settles at the “normal” 2 percent and if we take the “normal” real interest rate at 2 percent, interest on bonds would be expected to exceed 4 percent. This would again affect negatively emerging market economies including Turkey.
9- In this context, I believe that “tension” will be the main trend in Turkey and peer countries. Of course not permanently, we will witness times of relief as well as those of high tension. But at the end of the current phase, however, the main trend (the average) will be the latter.
10- Turkey is on the high ranks of the emerging market economies with highest foreign finance requirement. Add to this the foreign circumstances specific to Turkey and elections on the horizon. All are additional causes of risk for Turkey.
11- It would be useful it the Central Bank considers the framework I summarized above.
This commentary was published in Radikal daily on 31.08.2013
