The data flow in the U.S. and Europe continued to give bad surprises in the week behind. The week started in a depressed mood with the prolonged repercussions of the jobless claims that had jumped to 500K the week before, while the dismal data continued to hit the prospects regarding the pace of growth with the U.S. July home sales dipping to the lowest level of the last 15 years and PMIs in the Eurozone, which had posted a surprisingly high growth in Q2, deteriorating in August. The dismal outlook pushed the stock markets lower to test their weak levels suffered in the beginning of July amidst the EU debt crisis, while the long term bond yields headed towards their historic lows. In due course, markets were all ears for Fed Chairman Bernanke’s speech in Jackson Hole conference, wondering the possible monetary policy measures that could be taken in the “unusually uncertain” economic outlook, as he describes.
Recall that in testimony to U.S. Congress in July, Fed Chairman Bernanke had outlined several options available to Fed if the “recovery seems faltering”: 1) Further changes or modifications to their language on interest rate strategy, 2) lowering the interest rate they pay on excess reserves and 3) changes in their balance sheet - either not letting securities run off or making additional purchases. In August FOMC meeting, the Fed introduced the third option by announcing that the Federal Reserve's holdings of securities would be kept constant at their current level and this decision paved the idea that the Fed sees the economic recovery as faltering. The chance of further expansion in quantitative easing, i.e. enlarging the Fed’s holding of securities, is believed to be more likely nowadays. However, at the same time, there are signs that even the Fed’s decision to keep the portfolio size constant rather than letting it diminish was a close call, with a higher-than-expected number of FOMC members opposing the idea. Accordingly, there is a challenging period ahead for Bernanke, since he has to fine tune the Fed’s policy action by taking into account that aggressive steps may fuel the panic even further while on the other hand, a less assertive position may fail to break the negative feedback loop.
We have been long emphasizing that the economic recovery would be very gradual and extended through time, considering that the housing sector and labor market took big hits from the recession. However, we consistently argue that even though we envisage a slowdown in economic activity this would not turn into a double dip thanks to the fast rebound enjoyed in global trade, as well as the relatively more robust outlooks of the most manufacturing sectors. Moreover, the manufacturers are cautious and reluctant to build up much inventory this time due to the sluggish nature of recovery, thus eliminating the chance of being caught by lofty stocks amidst periods of sudden decline in demand. Neither the leading indicators such as PMIs, nor the shape of the yield curves (accepted to be harbinger of recession when negatively sloped) suggest that the economy would head into a recession in the near future. Nevertheless, if the sell-off pressure and the market volatility remain for a long time, this may weaken consumer and business confidence, eventually transforming the current slowdown into contraction.
Meanwhile, the fresh data on domestic economic activity also suggested slowdown in economic activity. Capacity utilization rate in August rose by 5.2 pp y/y to 73.4%, which is worse than the market consensus for 74.1%. The seasonally adjusted index that we calculate edged down by 0.1 pp m/m to 73.0%. The index has been hovering at around 73% since April and hints that after gaining steam in the beginning of the year, the economic activity can barely hold gains, without any progress. Meanwhile, the RSCI dropped to 111.0 in August, with 1.7 pp m/m decrease. Nevertheless, the current level is much higher than the critical threshold of 100, which separates the expansion and contraction periods in the economy and therefore it is consistent with ongoing growth, albeit at a slower pace. The index is some 7.8 pp lower than its recent peak at 118.8, 4 months ago. The limited revival in the capacity utilization rate and Real Sector Confidence Index in July is not sustained in August, the fresh data showed. The leading activity indicators point that the recovery continues at a sluggish pace, without gaining any momentum. This outlook is in line with the global trends and fits into the trajectory envisaged by the Central Bank. Accordingly, the data supports the base scenario where interest rates remain low for more going forward. However, if the recent downbeat data regarding the global economy deteriorates even further, this would have the risk of slowing the already fragile domestic economy beyond expectations. Note that in the Inflation Report, the Central Bank assumed to resume rate cuts in such a scenario.
On the other hand, there were also fresh statements about the fiscal discipline and budget performance within the week behind. Both the comments by Finance Minister and Deputy Minister in charge of economy indicated that the budget deficit would end the year in line with the Medium Term Plan (MTP), which had put the target at 4.9%. We had previously argued that a better-than-target balance would have been the natural result of the (likely) significant upward revision in the 3.5% GDP growth, as well as the robust fiscal performance in 1H this year. (Please see August 16th). Therefore, if the realizations turned out to be close to the target, this would have been a signal of dismal budget performance in 2H. Deputy Minister Babacan said both the revenues and expenditures surface above the presumed levels, hinting that the robust revenue performance is used to finance above-forecast expenditures. Even though Babacan was the most dedicative advocate of the fiscal rule in the government, he chose to remain silent against the questions by saying that he will not make any comment on fiscal rule for a while. Therefore, the fiscal bill seems less likely to come to the agenda when the Parliament convenes in October, while it is also uncertain whether the rule would be applied to the following years.
In conclusion, the string of dismal data flow in developed countries hits recovery prospects and urges markets to demand more from monetary policy. However, the monetary authorities should balance their decisions in a way to fine tune between being more aggressive than the market expects and failing to give less than the market hopes. In due course, the data disclosures regarding the domestic economy assure the ongoing slowdown in growth rate and support the current monetary policy stance. However, if the recent downbeat data regarding the global economy deteriorates even further, the Bank may revisit their strategy. Meanwhile, there are growing signs that the fiscal policy would not give the expected support to the monetary policy.
31 Ağustos 2010 Salı
13 Ağustos 2010 Cuma
Don’t Take My Word For It…
The Fed’s decision about purchases of new securities to ease monetary policy was the key development in the external arena last week, while at home the focus was on the news regarding the delay of the fiscal rule, which would not be ready for 2011 budget and which would be subject to parameter changes.
Let’s start with looking into the Fed decision first: The Bank announced that they would reinvest principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities so that the Federal Reserve's holdings of securities would be kept constant at their current level. The Fed had purchased some US$1.25trn of mortgage-backed securities and some US$175bn of other agency debt. Considering that Fed had previously planned to gradually narrow their security portfolio in the context of exit strategy, this new decision pointed to a looser monetary stance. Recall that in testimony to U.S. Congress in July, Fed Chairman Bernanke had outlined several options available to Fed if the “recovery seems faltering”: Further changes or modifications to their language on interest rates strategy, lowering the interest rate they pay on excess reserves and changes in their balance sheet - either not letting securities run off or making additional purchases. Therefore, Fed’s decision to activate one of these options implied that the Fed sees the economic recovery as faltering. In essence, Fed also downgraded their assessment of the economic outlook in the FOMC statement. The key developments, in our opinion, that urged the Bank to change monetary stance were the non-farm payrolls and unemployment rate. After the job losses reached 8.3 mn, accompanied by the unemployment rate peaking at 10.1%, the labor market indicators have improved somewhat. However, over the last months, the increase in private payrolls and the decline in unemployment rate have cut pace. After the FOMC meeting, the 10-year U.S. Treasury yield slumped to 2.7%, the lowest of the year (vs. the historical low of 2%), while rate hike expectations have been postponed towards 2012 in the Fed fund futures. This outlook may be an important indicator that the interest rates would remain low across the globe for longer-than-expected.
As opposed to this external support for low interest rate environment, the news at home that the fiscal rule would not be applied for 2011 budget brought the risk of erasing the positive repercussions. The Central Bank had said they monitor fiscal policy developments closely while formulating monetary policy and that the fiscal space created by the stronger-than-expected economic activity leading to better-than expected performance in budget revenues should be used mostly to reduce the government debt stock. The Bank also had noted that should the fiscal discipline implemented through institutional and structural improvements, such as enacting and establishing the fiscal rule, it would be possible to keep policy rates at single-digit levels over the medium term. Despite the Bank’s sensitivity to this issue, it is not straightforward to assume that the recent developments regarding the fiscal rule would yield a change in monetary policy stance. Given the fact that the monetary policy did not even react to the substantial deformation in budget vs. the targets during the crisis, it is not easy to speculate whether this time would be different. A possible scenario may involve the Bank saying that they would continue monitoring how the fiscal space created by higher-than-expected revenues would be spent. If they chose to do so, they may later say they are satisfied with the 2011 budget being prepared with respect to the framework described in the previous MTP. Finally, they may even end up saying that “the fiscal rule would have been better, yet the implementation is more important.”
The best we can do now is watching the current trend in the fiscal outlook on one hand and on the other hand to dig into the budget targets for 2010-2012 to be described in the MTP due out in September ahead of the submission of the 2011 budget to the Parliament’s approval on October 17th. Glancing at the performance as of June, the 12-month rolling central government budget deficit to GDP ratio, which is the best indicator for trend, declined to 4.3%, accompanied with 0.9% primary surplus (0.5% primary deficit in IMF defined figures). This picture guarantees that the deficit would remain below the 4.9% target by the year-end even in the absence of any y/y improvement. Our guess is that the deficit would regress to 3.7%, assuming that there would be no additional expenditure burden. To put it differently, meeting the official year-end target for the deficit or surpassing the levels mentioned above would simply imply deterioration for the second half of the year.
No doubt, when the new MTP is disclosed, the target for 2010 budget deficit should be expected to be revised down on the back of upgraded growth forecasts (to 5.5% or 6.0% from 3.5%). The extent of revision is important, yet more important than that would be whether the 2011 and 2012 deficit targets (4.0% and 3.2%) would be modified. For example, if the long run targets of 1.0% budget deficit and 5.0% GDP growth in the fiscal rule were applied, the budget deficit would have to be brought down to 3.1% in 2011 and to 2.8% in 2012, based on our 3.7% estimate for 2010 budget. Therefore, in essence, the officials’ announcements that the budget would be prepared in line with the MTP indicate at a looser fiscal stance than the original framework assumed when the MTP had been first disclosed last year, as the 2010 outlook is much better than the targets.
Upon the news regarding the delay of the fiscal rule, the rating agencies ruled out direct linkage between the fiscal rule and ratings, as expected. Yet they raised concerns regarding the credibility of the government in the absence of the rule, while underscoring that the implementation is more important than the fiscal rule itself, so that the patterns of budget deficit and debt/GDP ratios going forward would be important for the ratings.
In conclusion, the perceptions regarding the growth outlook have deteriorated after the Fed decided to keep constant the security portfolio size, which was one of the alternative measures previously outlined by Fed Chairman Bernanke, should the economic recovery falters. Meanwhile, Fed’s decision has also created an appropriate background for the interest rates to remain low for longer than expected. The news regarding the delay of the fiscal rule at home has the risk of jeopardizing the interest-rate-friendly atmosphere. Nevertheless, the Central Bank seems unlikely to develop a monetary policy response against this despite their previous emphasis on the importance of fiscal rule. The Bank may prefer to monitor the budget outcome for some more time. The rating agencies also tend to favor a similar approach.
Let’s start with looking into the Fed decision first: The Bank announced that they would reinvest principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities so that the Federal Reserve's holdings of securities would be kept constant at their current level. The Fed had purchased some US$1.25trn of mortgage-backed securities and some US$175bn of other agency debt. Considering that Fed had previously planned to gradually narrow their security portfolio in the context of exit strategy, this new decision pointed to a looser monetary stance. Recall that in testimony to U.S. Congress in July, Fed Chairman Bernanke had outlined several options available to Fed if the “recovery seems faltering”: Further changes or modifications to their language on interest rates strategy, lowering the interest rate they pay on excess reserves and changes in their balance sheet - either not letting securities run off or making additional purchases. Therefore, Fed’s decision to activate one of these options implied that the Fed sees the economic recovery as faltering. In essence, Fed also downgraded their assessment of the economic outlook in the FOMC statement. The key developments, in our opinion, that urged the Bank to change monetary stance were the non-farm payrolls and unemployment rate. After the job losses reached 8.3 mn, accompanied by the unemployment rate peaking at 10.1%, the labor market indicators have improved somewhat. However, over the last months, the increase in private payrolls and the decline in unemployment rate have cut pace. After the FOMC meeting, the 10-year U.S. Treasury yield slumped to 2.7%, the lowest of the year (vs. the historical low of 2%), while rate hike expectations have been postponed towards 2012 in the Fed fund futures. This outlook may be an important indicator that the interest rates would remain low across the globe for longer-than-expected.
As opposed to this external support for low interest rate environment, the news at home that the fiscal rule would not be applied for 2011 budget brought the risk of erasing the positive repercussions. The Central Bank had said they monitor fiscal policy developments closely while formulating monetary policy and that the fiscal space created by the stronger-than-expected economic activity leading to better-than expected performance in budget revenues should be used mostly to reduce the government debt stock. The Bank also had noted that should the fiscal discipline implemented through institutional and structural improvements, such as enacting and establishing the fiscal rule, it would be possible to keep policy rates at single-digit levels over the medium term. Despite the Bank’s sensitivity to this issue, it is not straightforward to assume that the recent developments regarding the fiscal rule would yield a change in monetary policy stance. Given the fact that the monetary policy did not even react to the substantial deformation in budget vs. the targets during the crisis, it is not easy to speculate whether this time would be different. A possible scenario may involve the Bank saying that they would continue monitoring how the fiscal space created by higher-than-expected revenues would be spent. If they chose to do so, they may later say they are satisfied with the 2011 budget being prepared with respect to the framework described in the previous MTP. Finally, they may even end up saying that “the fiscal rule would have been better, yet the implementation is more important.”
The best we can do now is watching the current trend in the fiscal outlook on one hand and on the other hand to dig into the budget targets for 2010-2012 to be described in the MTP due out in September ahead of the submission of the 2011 budget to the Parliament’s approval on October 17th. Glancing at the performance as of June, the 12-month rolling central government budget deficit to GDP ratio, which is the best indicator for trend, declined to 4.3%, accompanied with 0.9% primary surplus (0.5% primary deficit in IMF defined figures). This picture guarantees that the deficit would remain below the 4.9% target by the year-end even in the absence of any y/y improvement. Our guess is that the deficit would regress to 3.7%, assuming that there would be no additional expenditure burden. To put it differently, meeting the official year-end target for the deficit or surpassing the levels mentioned above would simply imply deterioration for the second half of the year.
No doubt, when the new MTP is disclosed, the target for 2010 budget deficit should be expected to be revised down on the back of upgraded growth forecasts (to 5.5% or 6.0% from 3.5%). The extent of revision is important, yet more important than that would be whether the 2011 and 2012 deficit targets (4.0% and 3.2%) would be modified. For example, if the long run targets of 1.0% budget deficit and 5.0% GDP growth in the fiscal rule were applied, the budget deficit would have to be brought down to 3.1% in 2011 and to 2.8% in 2012, based on our 3.7% estimate for 2010 budget. Therefore, in essence, the officials’ announcements that the budget would be prepared in line with the MTP indicate at a looser fiscal stance than the original framework assumed when the MTP had been first disclosed last year, as the 2010 outlook is much better than the targets.
Upon the news regarding the delay of the fiscal rule, the rating agencies ruled out direct linkage between the fiscal rule and ratings, as expected. Yet they raised concerns regarding the credibility of the government in the absence of the rule, while underscoring that the implementation is more important than the fiscal rule itself, so that the patterns of budget deficit and debt/GDP ratios going forward would be important for the ratings.
In conclusion, the perceptions regarding the growth outlook have deteriorated after the Fed decided to keep constant the security portfolio size, which was one of the alternative measures previously outlined by Fed Chairman Bernanke, should the economic recovery falters. Meanwhile, Fed’s decision has also created an appropriate background for the interest rates to remain low for longer than expected. The news regarding the delay of the fiscal rule at home has the risk of jeopardizing the interest-rate-friendly atmosphere. Nevertheless, the Central Bank seems unlikely to develop a monetary policy response against this despite their previous emphasis on the importance of fiscal rule. The Bank may prefer to monitor the budget outcome for some more time. The rating agencies also tend to favor a similar approach.
9 Ağustos 2010 Pazartesi
Deserves More Reserves…
The Central Bank of Turkey decided to increase the maximum daily amount to be purchased in F/X auctions in order to accelerate the foreign exchange reserve accumulation, citing that capital flows to Turkey have recently grown more stable on the back of the latest developments in global financial markets, as was the case in other emerging market economies. This was not much surprise, considering that the Bank had already been signaling for such moves. In fact, the strengthening tendency of the short term capital flows, which indicates at deterioration in quality of current account deficit financing, has been observed through the balance of payments statistics since the beginning of this year. In January-May period, foreign investors’ portfolio inflow reached a cumulative US$11.6bn, with half of that amount being the purchases in the bond and equity market, while the increase in the deposits, which we believe to be linked with the swap transactions, made the other half. A more recent data posted by the Central Bank in the weekly publication of Non-residents' Holdings of Securities’ indicate at US$7bn year-to-date foreign purchases in the bond market and US$1.3bn in the equity market as of end-July. Note that some US$2.6bn of the total purchases were realized in the last 7 weeks. No doubt, these types of capital flows are exposed to abrupt changes in risk appetite. Yet, these flows have been continuing for quite some time and there are signs that they may get stronger, both of which paved the way for the CBRT to step for raising the F/X purchase size. On the other hand, the CBRT could have well taken this decision by Q2, but the decline in the F/X-liquidity of the banks discouraged the Bank. The steep contraction of residents’ foreign currency deposits in April-June period had dismal impact on the claims from banks abroad. Back then, the interest rate on foreign currency deposits scaled up, while the TRY swap rates came down visibly linked to the increase in banks’ demand for cross-currency swaps. This outlook has been reversed since mid-June and the F/X liquidity rose even above the level in April. Therefore, the Bank was able to raise the foreign currency reserve requirements and the F/X purchase auction size, one after another, both of which would suppress the F/X liquidity.
The Central Bank shows reserve accumulation as the reason behind the increase in F/X purchase auction size. In essence, reserve accumulation is the Bank’s strategic decision valid since liquidity amplified from 2002 onwards. A lot of Central Banks, in particular in Asia, followed this strategy, consequently boosting purchases of U.S. Treasuries and hence letting the U.S. economy to sustain a large current account deficit for very long time. The national reserves surged to US$75.6bn as of end-June from US$21.6bn in the beginning of 2002. However, in percent of GDP, these nominal values translate into a slight increase to 10.5% from 9.3%. This reserve ratio puts Turkey at a rank of 20 in the World, lower than the country’s GDP ranking at 17. The IMF data base, known as COFER, for the total reserve positions in the World show that the total reserves stand at US$8.3trn as of the end-Q1, with 61.5% being US$-denominated and the 27.2% being EUR-denominated. The highest-reserve countries are China (US$2.5trn), Japan (US$1.0trn) and Russia (US$0.5trn), while Brazil has the 8th biggest reserve position with some US$257bn (16% of GDP).
Looking at Turkey’s current reserve position through different ratios, for example reserves to GDP or as a more meaningful measure reserves to external liabilities, underscores the need for accumulating more reserves, especially considering that some US$11bn of the gross reserves are the deposits of the Turkish workers residing abroad. In the literature, the acceptable levels of reserves are described to be the 4-6 months of imports or principal and interest repayments of foreign currency-denominated domestic and external debt maturing in one year. Turkey’s reserve position more than satisfies these thresholds. Nevertheless, the reserves to short term external debt and imports are far from their peaks in 2000-2010 period. The reserves to imports is a measure of how long a country can sustain the inputs needed from abroad without relying on any external financing. The reserves to short term debt, on the other hand, shows what part of the foreign currency debt can be redeemed in the absence of external borrowing. The higher these ratios, the lower the risk premium of these countries, especially the ones with high external debt and hence the less costly would be their external borrowing.
Meanwhile, further details regarding the current structure of the Central Bank reserves are available in the monthly data of International Reserves / Foreign Currency Liquidity The expected foreign currency outflows within a year, as provided in this publication, also underscore the need for reserve accumulation. The Central Bank reports some US$21.7bn of predetermined short-term drains on foreign currency loans, securities and deposits. Even though an important part of this amount would be rolled over, this loaded outflow schedule indicates at the need for regular F/X purchase auctions just to maintain the current reserve level.
In conclusion, the strengthening of capital inflows that played a key role in the external financing this year, as well as the improvement of the F/X liquidity of banks towards normal levels, paved the way for the Central bank to increase F/X purchases in order to accelerate reserve accumulation. When considered together with the recent increase in foreign currency required reserve ratio, the Bank’s attempts address the F/X liquidity and they seem to be in line with the policy of not intervening to the foreign exchange rate level. The Central Bank reserves displayed a rapid increase after 2001 crisis and almost quadrupled since then. However, comparisons based on different criteria and the predetermined F/X outflows underscore the need for maintaining the strategic decision to accumulate reserves going forward.
The Central Bank shows reserve accumulation as the reason behind the increase in F/X purchase auction size. In essence, reserve accumulation is the Bank’s strategic decision valid since liquidity amplified from 2002 onwards. A lot of Central Banks, in particular in Asia, followed this strategy, consequently boosting purchases of U.S. Treasuries and hence letting the U.S. economy to sustain a large current account deficit for very long time. The national reserves surged to US$75.6bn as of end-June from US$21.6bn in the beginning of 2002. However, in percent of GDP, these nominal values translate into a slight increase to 10.5% from 9.3%. This reserve ratio puts Turkey at a rank of 20 in the World, lower than the country’s GDP ranking at 17. The IMF data base, known as COFER, for the total reserve positions in the World show that the total reserves stand at US$8.3trn as of the end-Q1, with 61.5% being US$-denominated and the 27.2% being EUR-denominated. The highest-reserve countries are China (US$2.5trn), Japan (US$1.0trn) and Russia (US$0.5trn), while Brazil has the 8th biggest reserve position with some US$257bn (16% of GDP).
Looking at Turkey’s current reserve position through different ratios, for example reserves to GDP or as a more meaningful measure reserves to external liabilities, underscores the need for accumulating more reserves, especially considering that some US$11bn of the gross reserves are the deposits of the Turkish workers residing abroad. In the literature, the acceptable levels of reserves are described to be the 4-6 months of imports or principal and interest repayments of foreign currency-denominated domestic and external debt maturing in one year. Turkey’s reserve position more than satisfies these thresholds. Nevertheless, the reserves to short term external debt and imports are far from their peaks in 2000-2010 period. The reserves to imports is a measure of how long a country can sustain the inputs needed from abroad without relying on any external financing. The reserves to short term debt, on the other hand, shows what part of the foreign currency debt can be redeemed in the absence of external borrowing. The higher these ratios, the lower the risk premium of these countries, especially the ones with high external debt and hence the less costly would be their external borrowing.
Meanwhile, further details regarding the current structure of the Central Bank reserves are available in the monthly data of International Reserves / Foreign Currency Liquidity The expected foreign currency outflows within a year, as provided in this publication, also underscore the need for reserve accumulation. The Central Bank reports some US$21.7bn of predetermined short-term drains on foreign currency loans, securities and deposits. Even though an important part of this amount would be rolled over, this loaded outflow schedule indicates at the need for regular F/X purchase auctions just to maintain the current reserve level.
In conclusion, the strengthening of capital inflows that played a key role in the external financing this year, as well as the improvement of the F/X liquidity of banks towards normal levels, paved the way for the Central bank to increase F/X purchases in order to accelerate reserve accumulation. When considered together with the recent increase in foreign currency required reserve ratio, the Bank’s attempts address the F/X liquidity and they seem to be in line with the policy of not intervening to the foreign exchange rate level. The Central Bank reserves displayed a rapid increase after 2001 crisis and almost quadrupled since then. However, comparisons based on different criteria and the predetermined F/X outflows underscore the need for maintaining the strategic decision to accumulate reserves going forward.
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