Global Investing

Could the Turkish central bank surprise markets again today?

Given its track record, few will dare to place firm bets on the outcome of today’s meeting but the general reckoning for now is that the bank will keep borrowing and lending rates steady and signal no immediate change to its weekly repo rate of 5.75 percent. With year-on-year inflation in the double digits, logic would dictate there is no scope for an easier monetary policy.

But there are reasons to believe the Turkish central bank, whose mindset is essentially dovish, is letting its thoughts stray towards rate cuts. Consider the following:

a) Governor Erdem Basci has already said he does not see the need for further policy tightening  b)The lira has strengthened  9 percent this year against the dollar and is back at levels last seen in early September, thanks to almost one billion dollars in foreign flows to the Turkish stock market and well-subscribed bond issues. And crucially c) Global factors are supportive (developed central banks are continuing to pump liquidity and a bailout  has finally been agreed for Greece) .

So some analysts are already weighing the likelihood of a pre-emptive rate cut in Turkey. ING analyst Sengul Dagdeviren writes:

Depending on the CBT’s view on capital inflows (ECB LTRO due soon, quantitative easing bias strengthening in G10, and Greece worries diminishing look supportive in that regard), the chance that it could surprise markets by lowering the upper band of the overnight interest rate corridor to 9 percent (down from 12.5 percent) remains.

Bahrain’s civil unrest — which had a one-year anniversary this week — has taken a toll on the local economy and left a deep scar on the Gulf state’s aspiration to become an international financial hub.

A new paper from the Sovereign Wealth Fund Initiative, a research programme at Center for Emerging Market Enterprises (CEME) at the Fletcher School at Tufts University, examines how the political instability of 2011 is threatening Bahrain’s efforts in the past 30 years to diversify its economy and develop the financial centre.

Asim Ali from University of Western Ontario and Shatha Al-Aswad, assistant vice president at State Street, argue in the paper that even before the revolt, Bahrain lagged in building the foundations of a truly international hub in the face of competition from Dubai and Qatar.

Anticipation is running high for the ECB’s LTRO 2.0 due on Feb 29.

The first such operation in December has largely benefited peripheral bonds even though estimates show banks used a bulk of their borrowing (seen at  just 150-190 bln euros on a net basis) to repay their debt, as the graphic below shows.

At the second LTRO, banks are expected to use the proceeds to pay down their debt further. That is a good news for non-bank corporate credit because banks — busy deleveraging — are more likely to repay existing debt than roll over and existing holders of bank debt will need to look elsewhere to allocate their assets.

“Apart from the shrinking size of (European bank bonds) some investors might want to get out of them anyway and allocate assets somewhere else… Credit spreads are pricing in a very pessimistic scenario. There’s a very good value in non-banking credit,” says Didier Saint-Georges, member of the investment committee at French asset manager Carmignac Gestion.

At a monetary policy event hosted by Fathom Consulting at the Reuters London office today, former Bank of England policymakers were discussing the pros and cons of “financial repression”.

Financial repression is a concept first introduced in the 1970s in the United States and is becoming a talking point again after the financial crisis, especially with a NBER paper last year written by economists Reinhart and Sbrancia reviving the debate.

In the paper, authors define financial repression as follows:

Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of “financial repression”.

As January 2012 drifts into the rearview mirror as a bumper month for world markets, one way to capture the year so far is in pictures – thanks to Scott Barber and our graphics team.

The driving force behind the market surge was clearly the latest liquidity/monetary stimuli from the world’s central banks.

The ECB’s near half trillion euros of 3-year loans  has stabilised Europe’s ailing banks by flooding them with cheap cash for much lower quality collateral. In the process, it’s also opened up critical funding windows for the banks and allowed some reinvestment of the ECB loans into cash-strapped euro zone goverments. That in turn has seen most euro government borrowing rates fall. It’s also allowed other corporates to come to the capital markets and JP Morgan estimates that euro zone corporate bond sales in January totalled 46 billion euros, the same last year and split equally between financials and non-financials..

China moved to ease policy this week via a reserve ratio cut for banks, effectively starting to reverse a tightening cycle that’s been in place since last January. Later the same day, Brazil’s central bank cut interest rates by 50 basis points for the third time in a row. Both countries are expected to continue easing policy as the global economic downturn bites. And last week Russia signalled that rate cuts could be on the way.

That makes three of the four members of the so-called BRIC group of the biggest emerging economies. Indonesia, the country some believe should be included in the BRIC group, has also been cutting rates. That leaves India, the fourth leg of the BRICs, the quartet whose name was coined by Goldman Sachs banker Jim O’Neill ten years ago this week. India could use a rate cut for sure. Data this week showed growth slowing to 6.9 percent in the three months to September — the slowest since September 2009. Factory output slowed to a 32-month low last month, feeling the effects of the global malaise as well as 375 basis points in rate increases since last spring. No wonder Indian stocks, down 20 percent this year, are the worst performing of the four BRIC markets.

But unlike the other BRICs, a rate cut is a luxury India cannot afford now — inflation is still running close to double digits.  “The Reserve Bank of India (RBI) is the odd guy out due to stubbornly high inflation of near 10 percent,” writes Commerzbank analyst Charlie Lay.

Recent weeks have witnessed an interesting  split between countries that are raising interest rates to fend off runs on their currencies, and those cutting rates to spur on growth — check out my colleague Carolyn Cohn’s recent piece on this topic (http://tinyurl.com/4x58ny6) .The frontier economies of Africa fall into the first category — Kenya this week jacked up rates by an unprecedented 550 basis points to ward off a currency collapse, while Uganda’s benchmark rate was increased by 300 bps.  

Big stable economies such as Australia, Brazil and Indonesia have cut interest rates. On Wednesday, Romania became the latest  country to do so.  But an exception is investment grade Hungary, which may soon join the ranks of  frontier markets in currency-defensive rate hikes.

It may also soon lose its investment grade status –at least one of the three big rating agencies is expected to soon announce a cut to the sovereign credit rating.  That fear has triggered flight from the forint and short-dated bonds, pushing the currency to 2-1/2 year lows and causing significant flattening in the yield curve. The situation hasn’t been helped by signs the government is cooking up another sceme to subsidise indebted small businesses. More is to come, many predict –a ratings downgrade could see investors pull at least $1.2 billion euros from local bond markets. ING Bank estimates. That would be 10 percent of foreigners’ Hungarian bond holdings and would send the currency into a fresh tailspin.

Emerging central banks that sold billions of dollars over the summer in defence of their currencies might soon be forced to do the opposite. Japan’s massive currency intervention on Monday knocked the yen substantially lower not only versus the dollar but also against other Asian currencies.  The action is unlikely to sit well with other central banks struggling to boost economic growth and raises  the prospect of a fresh round of tit-for-tat currency depreciations. Already on Monday, central banks from South Korea and Singapore were suspected of wading into currency markets to buy dollars and push down their currencies which have recovered strongly from September’s selloff.  The won for instance is up 6.9 percent in October against the dollar — its biggest monthly gain since April 2009.  The Singapore dollar is up 4.5 percent, the result of a huge improvement in risk appetite.

Despite the interventions, the yen ended the session more than 2 percent lower against both the won and the Singapore dollar,  and most analysts reckon Japan’s latest intervention is by no means its last. That’s bad news for companies that compete with Japan on export markets and will keep neighbouring central banks watching for the BOJ’s next move. “Asian central banks are likely to play in the same game, and keep currencies competitive via regular interventions,” BNP Paribas analysts said.

But the race to the bottom has been underway for some time.  After all central banks in the West have cut rates, as in the euro zone, and embarked on more quantitative easing, as in the UK.  One bank, Switzerland’s, has gone as far as to effectively establish a ceiling for its currency.  And in Asia, Indonesia surprised markets with an interest rate cut this month while Singapore eased monetary policy. Many expect South Korea’s next move also to be a rate cut even though inflation is running well above target.  Analysts at Credit Agricole predicted this week’s G20 meeting to yield no fruitful discussion on what they termed “currency manipulation”. “This lack of co-ordinated policy could trigger an escalation in ongoing currency wars,” Credit Agricole analyst Adam Myers told clients. That would in turn lead to a renewed acceleration in central banks’ dollar reserves, he added.

Holding your breath for instant and comprehensive European Union policies solutions has never been terribly wise.  And, as the past three months of summit-ology around the euro sovereign debt crisis attests, you’d be just a little blue in the face waiting for the ‘big bazooka’. And, no doubt, there will still be elements of this latest plan knocking around a year or more from now. Yet, the history of euro decision making also shows that Europe tends to deliver some sort of solution eventually and it typically has the firepower if not the automatic will to prevent systemic collapse.
And here’s where most global investors stand following the “framework” euro stabilisation agreement reached late on Wednesday. It had the basic ingredients, even if the precise recipe still needs to be nailed down. The headline, box-ticking numbers — a 50% Greek debt writedown, agreement to leverage the euro rescue fund to more than a trillion euros and provisions for bank recapitalisation of more than 100 billion euros — were broadly what was called for, if not the “shock and awe” some demanded.  Financial markets, who had fretted about the “tail risk” of a dysfunctional euro zone meltdown by yearend, have breathed a sigh of relief and equity and risk markets rose on Thursday. European bank stocks gained almost 6%, world equity indices and euro climbed to their highest in almost two months in an audible “Phew!”.

Credit Suisse economists gave a qualified but positive spin to the deal in a note to clients this morning:

It would be clearly premature to declare the euro crisis as fully resolved. Nevertheless, it is our impression that EU leaders have made significant progress on all fronts. This suggests that the rebound in risk assets that has been underway in recent days may well continue for some time.

The withering complexity of a four-year-old global financial crisis — in the euro zone, United States or increasingly in China and across the faster-growing developing world — is now stretching the minds and patience of even the most clued-in experts and commentators. Unsurprisingly, the average householder is perplexed, increasingly anxious and keen on a simpler narrative they can rally around or rail against. It’s fast becoming a fertile environment for half-baked conspiracy theories, apocalypse preaching and no little political opportunism. And, as ever, a tempting electoral ploy is to convince the public there’s some magic national solution to problems way beyond borders.

For a populace fearful of seemingly inextricable connections to a wider world they can’t control, it’s not difficult to see the lure of petty nationalism, protectionism and isolationism. Just witness national debates on the crisis in Britain, Germany, Greece or Ireland and they are all starting to tilt toward some idea that everyone may be better off on their own — outside a flawed single currency in the case of Germany, Greece and Ireland and even outside the European Union in the case of some lobby groups in Britain. But it’s not just a debate about a European future, the U.S.  Senate next week plans to vote on legisation to crack down on Chinese trade due to currency pegging despite the interdependency of the two economies.  And there’s no shortage of voices saying China should somehow stand aloof from the Western financial crisis, even though its spectacular economic ascent over the past decade was gained largely on the back of U.S. and European demand.

Despite all the nationalist rumbling, the crisis illustrates one thing pretty clearly – the world is massively integrated and interdependent in a way never seen before in history. And globalised trade and finance drove much of that over the past 20 years. However desireable you may think it is in the long run, unwinding that now could well be catastrophic. A financial crisis in one small part of the globe will now quickly affect another through a blizzard of systematic banking and cross-border trade links systemic links.