Will Interest Rate Cuts Continue as a Cycle?
· What do we mean by the sentence "Policy is tight enough for disinflation"?
· What should we think about the inflation perspective of the Central Bank?
· Will the rate cuts continue as a cycle, how will this be reflected on exchange rates and inflation?
When we look at the interest path of the Central Bank and the prevailing economic and inflationary conditions, we will experience a period in which more than one answer can be given to these questions. In other words, the more the inflation expectations variant is opened, the same will be true for interest rate projections. In this regard, there is uncertainty about the degree of monetary tightness or the degree of monetary loosening in the new norms, especially about the criterion to be taken as a basis for the inflation indicator.
After Central Bank Governor Mr. Şahap Kavcıoğlu referred to core inflation, an unexpected 100 basis point rate cut was made in the September MPC. In an environment of increasing inflation, the latest indicators and the policy action taken show that the "interest on inflation" commitment has been abandoned. Instead, there is not enough clarity on whether the main inflation indicator should be considered as core inflation. Because Mr. Kavcıoğlu also said that “headline inflation was not put in the background” at the last economist meeting. He stated that the increase in inflation was due to accidental factors, that this was not in the intervention area of the Central Bank, and that the facts that increased the headline inflation were due to temporary factors. If we consider that the inflation, which the world has to deal with right now, is caused by supply problems, in a scenario where the bottleneck is not overcome, we can talk about the continuation of price pressure from energy and commodity prices.
What effect will the lira have here? The lira, which gave weight to depreciation after the Central Bank's reshuffle, may increase this depreciation momentum after the rate cut. Since we will give more weight to our expectations regarding this in the next section, we highlight only the macroeconomic and inflationary implications in this area. We will feel the effect of the exchange rate heavily on the costs originating from imports. While the flash reflection of this on the intermediate goods and energy side will occur in the producer inflation, we see the consumption goods effect more directly in the consumer inflation. On the other hand, the cumulative cost effect from PPI does not reflect directly or simultaneously to the CPI, but is reflected in different layers depending on the market conditions and demand. Therefore, the PPI of 44% does not indicate that inflation will go to that level exactly, but it does show that it can go much higher than 20%. That is, a certain degree of convergence can further increase inflation. We have to look at this through the secondary factor. This situation does not only apply to prices based on food and energy; Similar effects can be mentioned in basic goods and services.
We can summarize these secondary effects as follows; The fluctuation in commodity and energy prices has created short-term volatility. These effects, when analyzed alone, will leave their place to more normalized movements when global pricing behavior or negative base is eliminated. This is where the view of “temporality in inflation”, which the central banks administrations, especially the Fed, emphasizes. On the other hand, the fact that the Fed still continues the "tapering" communication, which we will detail in the related title, is because it wants to avoid the side effect of a policy laxity that will make an extra contribution to inflation. Considering that the main facts shaping inflation expectations are based on the general trend and current inflation components, volatility in prices also means deteriorated pricing behaviors. Deteriorated pricing behavior, on the other hand, may reflect on the general trend of inflation as volatility and high for a longer period of time. The price stability perspective of the Central Bank should also come into play here.
Under all these conditions, we think that the Central Bank should evaluate the risks and pause the rate cuts "even if it is based on core inflation". However, the progress and rhetoric in the current policy path show that the Central Bank will want to continue to cut interest rates. We think that we can see rate cuts to be distributed to the remaining 3 meetings of the year.
Comparison of Turkey consumer inflation, dollar/lira exchange rate and Bloomberg Commodity Price Index… (Source: Bloomberg, CBRT, TURKSTAT)
What Will Happen in the Currency Movement?
· Dollar/TRY hit all-time highs.
· What will be the main components in the exchange rate movement, are local or global factors more effective?
· How can we evaluate Turkey's position relative to other interest-raising EMs?
The depreciation pressure on the lira may continue. Globally, rising inflation expectations in the US weighing on the expectations of tapering from the Fed and the rise in US bond yields may put general pressure on EMs. At the same time, the concerns and uncertainties that the Central Bank entered the "early easing" cycle and unorthodox practices in an environment where inflation was risky lowered the yield of the lira. The increase in energy prices may also cause the segregation of energy importers and exporters in EM currencies. This is a disadvantageous situation. The depreciation effect of the lira is realized in a way that is a combination of local and global factors, and the loose return position increases this depreciation coefficient. If the Central Bank cuts further interest rates in this environment, the exchange rate may continue to rise.
We think that the real interest rate that the lira needs may increase. This alone was not a factor in depreciation, as policy rates are still below inflation in many EMs. However, we expect this to change and not be sustainable. As the reason for this;
· Increasing bond rates in the US will affect global capital movements.
· The fact that the change in energy prices will make exporting countries more advantageous, and that it will force energy importers like us in the context of macro balances, especially inflation.
· We can show the factors that many EM Central banks are preparing for the Fed cycle with monetary tightening.
We expect Turkey to make an exception to the monetary tightening issue within the EM group and to follow a looser policy. This situation can be expected to increase the depreciation pressure on the lira.
Comparison of TRY and other EM currencies after the March 19 CBRT change (normalized with Factor 100)… TRY depreciated by 25% after the said date and diverged negatively. (Source: Bloomberg)
“Sweet November” for Tapering
· As we continue to monitor the data for the Fed, do we see any factors that will delay the tapering statement in November?
· What effect will the Fed have?
We think that the Fed will now initiate the tapering phenomenon in order to avoid the harmful effects of monetary expansion. We analyze the impact of the factors that have the potential to create an obstacle to this, by separating the criteria for tapering and rate hikes. Under-expected increases in the labor market in August and September may undermine current trends, particularly the energy crisis and global stagflation concerns. On the other hand, we think that the "recovery in the economy and significant progress" phenomena will be the subject of rate hikes, and we expect that the tapering phenomenon will not be an obstacle.
Inflation is a problem… There has been a significant movement in short-term inflation expectations recently. On the other hand, the long-term side of the curve seems stable compared to the previous projection period. That is, inflation is high and volatile in the short run; it will be lower in the long run and this will not turn into a structural problem. However, we talked about the policy effectiveness of the Central Bank in terms of secondary effects and its reflections on pricing behavior. This is where the Fed's communications and toolkit comes in.
No "Land, ho!" has yet appeared on the issue of supply components and overcoming the supply shortage. The debt ceiling problem was not resolved, it was postponed to December. In other words, there is a "see you in December" situation (it is of serious importance in terms of the financial obligations of the public, it is necessary to look at the event both in terms of potential shutdown and Treasury default). A few more real estate companies in China seem to be in trouble, and there is no clear scenario analysis yet on the contagion effect. Regarding the global stagflation factor, there are risks of a slowdown in employment and an acceleration in inflation. All these conditions show that while the Fed is taking its steps in a tapering direction, it should proceed gradually. Our prediction is that the policy move will be in a soft transition format.
You can see the movements of inflation expectations in different maturities in the chart. According to the projections for the June period, there is a significant upward movement currently. The position of the curve has also shifted to the right as of October on the short-term side. Short-term prospects are moving upwards. (Source: Federal Reserve, Refinitiv)
The threshold point may be higher because the movement in recent bond yields is due to the expectation of an increase in inflation, not the improvement in conditions. After normalizing the 1.40 - 1.50% band in the 10-year term, there will be 1.70 - 75% potential and then 2% levels to be looked at. It can be expected that the upward slope will become steeper in the 2-year term, which is more sensitive to short-term inflation. The short-term side of the yield curve will be somewhat volatile.
US 2-year and 10-year bond yields… (Source: Bloomberg)
We expect the Fed to prioritize providing financial conditions compatible with inflation. For this reason, we think that despite the rough economic data regarding the tapering announcement at the November FOMC meeting, there will be no backtracking.
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