Capitalising on Global Trends…

The state of indecisiveness that characterised market sentiment in the early months of the year has given way to drastic changes in pricing as of the end of the first quarter. Apprehensions as to the strength of global recovery and Bank of Japan’s unprecedented quantitative easing decision have set the stage for dramatic declines primarily in commodity prices and long-term bond yields. This, on the other hand, sets an extremely supportive backdrop for Turkey’s economy and financial markets. Continuation of easy global liquidity conditions -- at a low cost -- and not leading to a bubble in asset prices is probably a dream scenario from Turkey’s perspective.

It appears that sub-potential growth once again in the first quarter and a downward course in commodity prices, most notably oil, will lead the deterioration in Turkey’s foreign trade and current account balances -- triggered by the recovery in domestic demand -- to be contained. It seems to us that the most recent decisions by the CBT are intended entirely “to weaken the link between capital flows and domestic macroeconomic variables such as credit and current account deficit”, and that the monetary authority has been relieved of the pressure from rate cut expectations, thanks also to a supportive global backdrop. We continue to believe that this general outlook reinforces credit rating upgrade expectations, potentially allowing agencies other than Fitch the opportunity to raise Turkey to investment-grade category.

Looking at the current state of affairs, the principal leading indicator, PMI indices, have continued to drift lower in March on a global scale, following the retreat in February, which attests to the slowdown in global recovery. As for the Turkish economy, growth in 1Q13, albeit definitely above the previous quarter, will nonetheless continue to undershoot potential growth rate. We did acknowledge that these developments could somewhat weigh on 2013 growth perceptions, though it is noteworthy that expectations still remain unchanged at 4.2% levels, based on survey findings. Despite a minor increase in YE13 inflation expectations towards 6.6%, 12- and 24-month forward looking inflation expectations remain closer to 6.0%. Nevertheless, considering the appreciation pressure on the TRL and sliding commodity prices, a deterioration in inflation expectations appears quite unlikely, in our view. Finally, these developments warrant minor changes to our forecasts, which we also provide in this report.

As for markets, we attach significant likelihood to a retest of earlier record highs for the BIST in the short term, buoyed by Moody’s rate hike expectations. Even in the event that expectations are fulfilled, however, we see it likelier for the market to switch to more of a range-bound trading pattern. Regarding interest rates, intervention by the Bank of Japan and actions by the CBT -- keen not to miss this opportunity -- have created a drastic change in outlook. While we continue to expect interest rates to follow an upward slope until the year end, compared to our earlier forecasts, we now expect increases to be more gradual and limited in magnitude. On the exchange rates front, given renewed intent by the CBT to take all measures necessary to surmount any pressure from capital flows, we continue to expect the currency basket to fluctuate within a band of 2.05 - 2.15 throughout the year, and not to dip below the 2.05 mark.

MPC Preview - All Roads Lead To Rome

The fourth Monetary Policy Committee (MPC) meeting of 2013 will be held on Tuesday, April 16. We perceive Bank of Japan’s (BOJ) unprecedented quantitative easing decision dated April 4 as a major “game changer”. This should also help alleviate uncertainties posed by the direction of capital movements, regarding which the most recent MPC meeting statement included the following prediction: “The Committee foresees that tighter liquidity policy along with weaker capital inflows will slow down credit growth”. Yet, the ensuing meeting minutes included the following statement, leaving the door open for the monetary authority to act in the event that the opposite case prevailed: “Necessary measures will be taken through liquidity policy, ROM, and reserve requirements should capital inflows re-accelerate”. In short, we expect the CBT to revert to its commonly known base scenario and to reiterate its following stance: “In order to contain the risks on financial stability due to strong capital inflows, the proper policy would be to keep interest rates at low levels while continuing with macroprudential measures”. To this end, we attach significant likelihood to a 50bp cut to both the policy rate and the interest rate corridor. Additionally, more dramatic increases in FX and TRL reserve requirements compared to early practices (50bp and 25bp), in a bid to intensify the sterilisation of capital inflows, could be expected, in our view. Such a move, on the other hand, would reduce the possibility of a new increase in reserve option coefficients (ROCs). Our forecasts are predicated on the assumption of a somewhat more aggressive stance by the CBT regarding interest rates and macroprudential measures compared to the consensus view.

In the early days of the month in progress, at a speech in Mardin, CBT Governor said a measured cut to the policy rate may come on the agenda should the REER top the 120 threshold. Indeed, according to our calculations, the REER is likely to exceed the 120 mark significantly in April if the TRL continues to trade at current levels (2.06) against the FX basket. Moreover, additional quantitative easing decisions by developed countries set the stage for policy rate cuts by emerging market (EM) central banks. The average policy rate of ten EMs -- that are closely monitored by the CBT as well -- has retreated to 5% levels at this point. The CBT, keen to maintain its relative position and to mitigate the appreciation pressure on the TRL, may seize this opportunity to eliminate the prevailing difference in interest rates.

However, the CBT would run the danger of being perceived to have apprehensions about growth, and using the REER as a pretext to deliver a policy rate cut, especially if such as decision is not counterbalanced by macroprudential measures. Therefore, the way the monetary authority chooses to communicate these decisions will be more important than ever to contain potential loss of credibility.

Investors might also recall that the CBT had withdrawn excess liquidity a few days before the March MPC meeting and embarked on active liquidity management thereafter; thus, repo rates had risen significantly. However, repo rates have started to fall sharply over the last few days, which could be considered as a probable end to liquidity squeeze ahead of the April MPC meeting. This might also imply that a borrowing rate cut will accompany a policy rate cut at this meeting, to ease the appreciation pressure on the TRL.