Summary: For those who want to see the glass half empty, the EU debt crisis has arisen as the most commonly used argument. In that context, Ireland has become an easy target to attack as the country has one of the most rapidly growing public debt stocks. However the real concern is the possible spill over of the debt saga to more important and bigger countries of Europe, such as Spain. However, Spain has one advantage (residents have a greater share in the debt market) that is not valid for the smaller EU countries. Turkey is in a relatively more advantageous position, as the country has not suffered any deterioration in the debt dynamics and the government debt is mostly owned by the residents. Turkey’s distinct position has been priced by the markets, while it is the rating agencies’ turn to reflect these favorable aspects to credit ratings.
The Eurozone debt crisis, China’s measures to cool off the economy and U.S. labor market that has failed to enjoy a meaningful rebound so far… All have become the major themes this year that feed into the pessimistic views regarding the global economy. These topics happened to be used alternately to justify the stock market sell-offs observed in the long term upward trend. The combination of all of these unpleasant factors tends to exaggerate the pressure even further. The markets have been suffering such bearishness over the last days that dampen the global risk appetite. The stock markets and the bond yields are tumbling, accompanied with a higher U.S. Dollar, lower commodity prices, yet a more valuable gold. Fortunately, the deterioration in sentiment seems to have remained limited. What then is preventing the gauges of risk appetite, such as the VIX index from climbing as extensively as was the case during the Greece debt crisis in May? One reason is that the EU acted quickly to launch the support mechanism, which is co-financed by the IMF (EFSF – European Financial Stability Facility), while the other reason is the relatively small size of Irish economy, like Greece. However, the severity of the problems regarding Ireland is not proportional to the size of the economy. The banking sector in Ireland has grown more than three times as big as GDP, with the main creditors being the private banks of big European countries. Therefore unlike Greece, where the public finances constitute the roots of the crisis, in the case of Ireland there is this fear of contagion to other countries. The real concern is the possibility of the debt problems spreading to more important countries in Europe, such as Spain, where CDS has already climbed to 310 bps, a warning that this risk has started to be partially priced. In order to soothe the fears about Ireland, the EU officials soon announced that some EUR80-90bn may be drawn from the EFSF to bail out Ireland. The details of the rescue package are expected to be shaped at the EU finance ministers’ summit on December 7th. In due course, the ECB has been providing EUR130bn to the Irish banks that correspond to 20% of their total assets. Ireland and Greece have the fastest growing public debt and explains why these countries have become targets for the markets.
At this point, one can question why other countries in the top 5, such as Japan, U.K. and the U.S. do not face similar pressure. We believe that the answer lies at the composition of the creditors. Non-residents own more than 70% of the total government debt instruments in countries like Greece, Ireland and Portugal. This structure of the bond market, where residents have much less power, intensifies the dismal impact from sell-off pressure during periods of surging fears regarding the public debt. Whereas, countries such as Japan, Canada or the U.K can avoid panic more easily, since the public debt is mostly owned by residents. In that context, Portugal and Spain which are often speculated to be the next destination of debt crisis stand at a distinct position and Spain is likely to tackle the pressure more easily despite the recent surge in their risk premiums. Glancing at Turkey’s position, the relatively limited foreign participation in the government debt securities seems to be another advantage for Turkey in the post-crisis environment. In fact, the increase in the debt stock has remained subdued in this period and the share of non-residents is still below 13%, despite some late up-tick. Turkey ranks among the countries with the lowest foreign participation in the public debt market after Japan and Canada. Turkey’s CDS trades at 140 bps as of November 25th, lagging below most developed and developing nations.
While the financial markets rate Turkey’s credit worthiness in the “investment grade,” thanks to the favorable growth performance that improves debt dynamics, there has also been improvement in the rating agencies’ view on the country. The outlook has been upgraded to positive on November 24th by Fitch, who already sees Turkey closer to the investment grade than their peers do. With this move, the big difference between the market valuations and the credit ratings tend to narrow a little bit. Fitch noted that implementation of fiscal policy consistent with a downward trend in the government debt-to-GDP ratio could result in upgrade, adding that if Turkey comes through parliamentary elections and prospective constitutional amendments without a material increase in political instability this would also be supportive. Gathering all these statements, it is understood that the earliest possible timing for upgrade would be after the general elections in mid-2011. This expectation would remain as a catalyst for relative strength of TRY assets.
26 Kasım 2010 Cuma
12 Kasım 2010 Cuma
From Disorder To This Order…
Summary: There has been a loss of faith in the current international financial system which was hit so deeply in the global crisis that the problems have been extended to this day. Accordingly, the suggestions for building a new global order are blowing up over the recent period. The members of the G20 are seeking a solution by not just talking but also pushing hard their policy options to speed up the way to the new equilibrium. Turkey is close to acquiring a stronger power in IMF and therefore having a greater responsibility in the international decision making arena.
Amidst the ongoing concerns over the global economy, the G20 leaders are dealing with a long agenda at their meeting on November 11th and 12th. The differences of views among countries seem to have become more visible after the Fed launched the new quantitative easing program on November 3rd. The emerging market members of the G20 group, including Turkey are expected to voice their concerns about the loose monetary policy of U.S. at the summit. In advance of the G20 meeting, World Bank President Zolleick proposed a new international monetary system involving multiple reserve currencies and including a role for gold as a reference point for market expectations of inflation and future currency values. We are not sure how seriously his comments are taken, but his thesis has drawn quite a lot of attention. What he is basically suggesting is to include Chinese Yuan to the synthetic currency unit SDR, which is composed of U.S. Dollar, Euro, Yen and Pound. On the other hand, there were two key propositions circulated in the media after the previous G20 meetings. One of them is the U.S. plan that advocates limiting the C/A balance by 4% of GDP. Based on IMF 2010 forecasts, the U.S. and Japan do not violate this rule with their 3.2% deficit and 3.1% surplus, respectively. China is close to the limit, as the country’s surplus is foreseen narrowing to 4.7% this year from 9% in 2008. On the other hand, in addition to the developed Asia such as Taiwan (+10%) and Hong Kong (+8.3%), Germany (6.1%) which is Europe’s engine of growth has excessive surplus. Turkey is also in the group of countries that exceed the suggested border line. Among the BRIC countries, Brazil and India have 2.6% and 3.1% deficit, in the same order, while Russia has 4.7% surplus. Some small countries even face high two-digit external balance ratios, yet they do not play a meaningful role in the global imbalances. Therefore, rather than agreeing on a quantitative target, G20 is likely to focus on the systemically important countries and carry on studies to determine the sustainable levels of C/A balance.
The second hot topic may be the banking regulations. The Financial Stability Board, the global body that implements the G20’s communiqués, is told to be mulling on a list of systemically important bank lists which would be subject to separate regulations. Financial Times claimed two separate systemic bank lists would be created, ‘the first with an estimated 20 global banks whose failure would pose a risk to the international financial system. The second would be a country-by-country list of banks that are systemically important within their home economies, but pose little danger to the world.’ Based on these criteria, Japan and China seem to be exempted given their limited international presence. In due course, the decision on a globally set capital surcharge for systemically important banks, that is in essence the core of arguments, may be delayed. On October 22nd, Deputy Prime Minister Babacan told in an interview with AA news agency that “they should decide about the big banks and start implementing it soon.” His remarks hinted that there are two separate lists being prepared for G20. Therefore, the big and systemically important banks in Turkey will likely take place in the second list. However, it is yet uncertain whether being in that list would be advantageous.
Another important issue for Turkey would be any change in the voting power in International Monetary Fund, a topic to be discussed at G20 summit as well. As in known, the Group of 20 leading economies has reached an agreement on a reform of the IMF’s quota and governing structure on November 5th to give a bigger voice to developing countries. With this reform, G20 agreed to double the IMF’s quotas (SDR476.8). The European countries will give up two of their eight seats on the 24-member board, giving more weight to emerging universe. Turkey, being raised to a quota of 0.98%, i.e. the 20th biggest share in IMF, is claimed to benefit the new structure and to gain one of those seats, based on the recent news flow. In the current mechanism, Turkey is being represented by Belgium.
Prior to the G20 summit, the focus was on especially the Chinese data. The large foreign trade surplus in October, together with strong industrial output that expanded by a rapid 13.1% and the inflation that surged to 4.4%, overshooting the Central bank target at 3% all justified China’s efforts to cool down the economy, such as the increase in policy rate and required reserve ratio. The risks to inflation and the additional quantitative easing in the U.S. seem to be putting China in a difficult position. If the country does not want to cool off the economy, they may eventually let Yuan appreciate in order to mitigate the inflationary pressures. Such a policy action would help reduce the global imbalances at a faster pace. U.S. Treasury Secretary Geithner emphasized this point at G20 summit in Seoul by saying that “China cannot continue to resist upward market pressure on its Yuan currency without facing higher inflation and rising asset prices.” He also said that “If you resist those market forces that are just a reflection of confidence that you're going to see strong growth in China, strong productivity growth in China, if you resist those market forces, that pressure is not going to go away it is just going to end up in higher inflation or higher asset prices and that'll be bad for China," while claiming that “China will be more confident in allowing Yuan rise if competitors’ currencies rise too. “
Amidst the ongoing concerns over the global economy, the G20 leaders are dealing with a long agenda at their meeting on November 11th and 12th. The differences of views among countries seem to have become more visible after the Fed launched the new quantitative easing program on November 3rd. The emerging market members of the G20 group, including Turkey are expected to voice their concerns about the loose monetary policy of U.S. at the summit. In advance of the G20 meeting, World Bank President Zolleick proposed a new international monetary system involving multiple reserve currencies and including a role for gold as a reference point for market expectations of inflation and future currency values. We are not sure how seriously his comments are taken, but his thesis has drawn quite a lot of attention. What he is basically suggesting is to include Chinese Yuan to the synthetic currency unit SDR, which is composed of U.S. Dollar, Euro, Yen and Pound. On the other hand, there were two key propositions circulated in the media after the previous G20 meetings. One of them is the U.S. plan that advocates limiting the C/A balance by 4% of GDP. Based on IMF 2010 forecasts, the U.S. and Japan do not violate this rule with their 3.2% deficit and 3.1% surplus, respectively. China is close to the limit, as the country’s surplus is foreseen narrowing to 4.7% this year from 9% in 2008. On the other hand, in addition to the developed Asia such as Taiwan (+10%) and Hong Kong (+8.3%), Germany (6.1%) which is Europe’s engine of growth has excessive surplus. Turkey is also in the group of countries that exceed the suggested border line. Among the BRIC countries, Brazil and India have 2.6% and 3.1% deficit, in the same order, while Russia has 4.7% surplus. Some small countries even face high two-digit external balance ratios, yet they do not play a meaningful role in the global imbalances. Therefore, rather than agreeing on a quantitative target, G20 is likely to focus on the systemically important countries and carry on studies to determine the sustainable levels of C/A balance.
The second hot topic may be the banking regulations. The Financial Stability Board, the global body that implements the G20’s communiqués, is told to be mulling on a list of systemically important bank lists which would be subject to separate regulations. Financial Times claimed two separate systemic bank lists would be created, ‘the first with an estimated 20 global banks whose failure would pose a risk to the international financial system. The second would be a country-by-country list of banks that are systemically important within their home economies, but pose little danger to the world.’ Based on these criteria, Japan and China seem to be exempted given their limited international presence. In due course, the decision on a globally set capital surcharge for systemically important banks, that is in essence the core of arguments, may be delayed. On October 22nd, Deputy Prime Minister Babacan told in an interview with AA news agency that “they should decide about the big banks and start implementing it soon.” His remarks hinted that there are two separate lists being prepared for G20. Therefore, the big and systemically important banks in Turkey will likely take place in the second list. However, it is yet uncertain whether being in that list would be advantageous.
Another important issue for Turkey would be any change in the voting power in International Monetary Fund, a topic to be discussed at G20 summit as well. As in known, the Group of 20 leading economies has reached an agreement on a reform of the IMF’s quota and governing structure on November 5th to give a bigger voice to developing countries. With this reform, G20 agreed to double the IMF’s quotas (SDR476.8). The European countries will give up two of their eight seats on the 24-member board, giving more weight to emerging universe. Turkey, being raised to a quota of 0.98%, i.e. the 20th biggest share in IMF, is claimed to benefit the new structure and to gain one of those seats, based on the recent news flow. In the current mechanism, Turkey is being represented by Belgium.
Prior to the G20 summit, the focus was on especially the Chinese data. The large foreign trade surplus in October, together with strong industrial output that expanded by a rapid 13.1% and the inflation that surged to 4.4%, overshooting the Central bank target at 3% all justified China’s efforts to cool down the economy, such as the increase in policy rate and required reserve ratio. The risks to inflation and the additional quantitative easing in the U.S. seem to be putting China in a difficult position. If the country does not want to cool off the economy, they may eventually let Yuan appreciate in order to mitigate the inflationary pressures. Such a policy action would help reduce the global imbalances at a faster pace. U.S. Treasury Secretary Geithner emphasized this point at G20 summit in Seoul by saying that “China cannot continue to resist upward market pressure on its Yuan currency without facing higher inflation and rising asset prices.” He also said that “If you resist those market forces that are just a reflection of confidence that you're going to see strong growth in China, strong productivity growth in China, if you resist those market forces, that pressure is not going to go away it is just going to end up in higher inflation or higher asset prices and that'll be bad for China," while claiming that “China will be more confident in allowing Yuan rise if competitors’ currencies rise too. “
5 Kasım 2010 Cuma
Just A Second...
Summary: While the markets seem to have been satisfied with the Fed’s decisions, the developing countries have once again started to feel the pressure of currency appreciation and the rapid capital inflows. In due course, Turkey continues to proceed with their plan to struggle amidst the new global economic backdrop and tries to intervene via new and old tools, where the constraint is the inflation outlook.
The long awaited decision by the FOMC has finally been revealed and the market reaction has so far been as expected. The Fed’s quantitative easing (QE) program has garnered almost all of the market attention that it even has taken the front seat to the U.S. midterm elections. Fed announced that they would purchase an additional $600bn of Treasury securities, with the overall purchases reaching $850mn-$900mn in 8 months, including some $250-300bn worth of reinvestments from the previous program. The assets purchased will have an average duration of between 5 and 6 years, which is the single feature of the program that may have created disappointment. Almost half of the assets will have a maturity of 5 to 10 years, while the 40% is planned to be of maturities between 2.5-5 years. Following the FOMC statement, the 2-year Treasury yield has slid to a historical low of 0.34% and the Fed funds futures indicate that no rate change is expected until the last quarter of 2012. Note that this is the case, despite the absence of any enhancement to the Fed’s phrase regarding the necessity of ‘low levels for the federal funds rate for an extended period’. Note also that ‘the Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed.’ This would leave the door open to changes in both directions. Moreover, just as the rate decisions are subject to growth and employment outlook, the above phrase assumes conditionality for the QE size and provides some flexibility to the Fed. As shall be recalled, the key properties of an ideal QE program mentioned in our comment published on October 12th listed exactly the same aspects. Therefore, the decisions did not come as a surprise. Accordingly, the financial markets have now returned to their positive trend and to the strong risk appetite environment. It seems that going forward, we will keep discussing about the appreciation pressure on TRY, as well as how further the country risk premiums and interest rates would fall, accompanied with the new record highs in the stock markets.
The Fed decisions would no doubt intensify the pressure on the emerging country central banks, which have already been dealing with the rapid capital inflows to their countries that result in appreciation of local currencies and has the risk of generating asset bubbles. Amidst this contentious environment, Turkey stands at a different point, being concerned with rapid domestic credit expansion and searching ways to suppress it, unlike the U.S. Turkish Central Bank Deputy Governor Basci told in a conference last week that Turkey should impede the credit expansion in its economy which has enjoyed a fast rebound after the global crisis and that new policy instruments may be required for that purpose. This was not much unexpected and the banking sector should be ready for creative and new tools, atop of the already introduced measures such as the increase in required reserves, abolishment of interest paid on reserves and the increase in the KKDF (Resource Utilization Support Fund) rate on consumer credits. The road-map regarding to these new instruments may be disclosed at the 2011 Foreign Exchange and Monetary Policy report due to be released at the beginning of the next month, the latest. However, the inflation pattern would play a critical role in order to give the Bank enough space to follow their plan.
Turkish Consumer Price Index rose by 1.83% m/m in October, overshooting the consensus, while the deviation from forecast was mostly due to the significant jump of 4.5% in food prices. Accordingly, the annual food inflation reached 17.1%, remaining above the Bank’s year-end assumption of 10.5%. The cumulative increase in food prices in the last two months of the last year was 7.7%, meaning that the prices should remain unchanged in the rest of this year in order to bring the annual inflation in line with the Bank’s forecast. Given the seasonal and other factors, this scenario seems quite unlikely. The unprocessed food prices that surged significantly over the last three months (from 8% to 31% y/y) have been the reason behind the elevated food component. In essence, the high level of volatility in food prices is one of the major obstacles against the process of disinflationary goals. A Central Bank study that covers the period between 2006-2009 shows that the volatility of monthly food price inflation in Turkey is 4 times of the EU-27, while this ratio goes up to 6 for the unprocessed food component, with Turkey having a higher volatility of monthly unprocessed food price inflation than each of the EU27 members. It should be noted that the volatility is two-sided and the inflation can fall as rapidly as it ascended. Nevertheless, recognizing that this would not happen all of a sudden, I revised my year-end CPI forecast to 7.7% from 7.2% due to the change in our food price assumptions. On the other hand, I continue to anticipate CPI easing to 6.0% by the end of 2011 with the help of the taming in food segment.
Contrary to the increase in the annual headline inflation, there were declines in the core indicators. The annual price change of the Central Bank’s favorite core indicator (excluding food, energy, gold, alcoholic beverages and tobacco), namely the “core-I” index, declined by a significant 1.2 pp m/m to 2.5%. While this is the sixth consecutive fall in annual core inflation, current level is its lowest level in the history of the series that started in 2003. Furthermore, the annual price change in services declined by 0.4 pp to 4.2%, again the lowest in the history of the series.
All in all, there is no doubt that the underlying inflation proceeds at a benign pace. Yet this does not change the fact that there is this disturbingly wide gap between the headline and the core. The Central Bank is also concerned with this issue by emphasizing the risk of jeopardy in pricing behavior. The Bank warns that they may hike earlier than planned, in case this risk materializes. On the other hand, the Central Bank seems quite comfortable here, as a recent CBRT working paper titled “A New Core Inflation Indicator for Turkey” concludes that ‘...when inflation deviates from core inflation, it converges back to the core inflation; but not the other way around.’ However, this does not necessarily mean that the headline CPI would converge to 2.5%. The empirical data show that even though there are cases where headline converges to the core, the two indices happen to meet somewhere in the middle following a significant decoupling.
Therefore, while the leading indicators warn against some revival in the economic activity going forward, it would unlikely ring any alarm bells in the Central Bank with such an encouraging underlying inflation trend. While this data is supportive of the already dovish stance of the Central Bank, we continue to expect the rate hikes to start in the last quarter of next year and amount to 100bps in 2011.
The long awaited decision by the FOMC has finally been revealed and the market reaction has so far been as expected. The Fed’s quantitative easing (QE) program has garnered almost all of the market attention that it even has taken the front seat to the U.S. midterm elections. Fed announced that they would purchase an additional $600bn of Treasury securities, with the overall purchases reaching $850mn-$900mn in 8 months, including some $250-300bn worth of reinvestments from the previous program. The assets purchased will have an average duration of between 5 and 6 years, which is the single feature of the program that may have created disappointment. Almost half of the assets will have a maturity of 5 to 10 years, while the 40% is planned to be of maturities between 2.5-5 years. Following the FOMC statement, the 2-year Treasury yield has slid to a historical low of 0.34% and the Fed funds futures indicate that no rate change is expected until the last quarter of 2012. Note that this is the case, despite the absence of any enhancement to the Fed’s phrase regarding the necessity of ‘low levels for the federal funds rate for an extended period’. Note also that ‘the Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed.’ This would leave the door open to changes in both directions. Moreover, just as the rate decisions are subject to growth and employment outlook, the above phrase assumes conditionality for the QE size and provides some flexibility to the Fed. As shall be recalled, the key properties of an ideal QE program mentioned in our comment published on October 12th listed exactly the same aspects. Therefore, the decisions did not come as a surprise. Accordingly, the financial markets have now returned to their positive trend and to the strong risk appetite environment. It seems that going forward, we will keep discussing about the appreciation pressure on TRY, as well as how further the country risk premiums and interest rates would fall, accompanied with the new record highs in the stock markets.
The Fed decisions would no doubt intensify the pressure on the emerging country central banks, which have already been dealing with the rapid capital inflows to their countries that result in appreciation of local currencies and has the risk of generating asset bubbles. Amidst this contentious environment, Turkey stands at a different point, being concerned with rapid domestic credit expansion and searching ways to suppress it, unlike the U.S. Turkish Central Bank Deputy Governor Basci told in a conference last week that Turkey should impede the credit expansion in its economy which has enjoyed a fast rebound after the global crisis and that new policy instruments may be required for that purpose. This was not much unexpected and the banking sector should be ready for creative and new tools, atop of the already introduced measures such as the increase in required reserves, abolishment of interest paid on reserves and the increase in the KKDF (Resource Utilization Support Fund) rate on consumer credits. The road-map regarding to these new instruments may be disclosed at the 2011 Foreign Exchange and Monetary Policy report due to be released at the beginning of the next month, the latest. However, the inflation pattern would play a critical role in order to give the Bank enough space to follow their plan.
Turkish Consumer Price Index rose by 1.83% m/m in October, overshooting the consensus, while the deviation from forecast was mostly due to the significant jump of 4.5% in food prices. Accordingly, the annual food inflation reached 17.1%, remaining above the Bank’s year-end assumption of 10.5%. The cumulative increase in food prices in the last two months of the last year was 7.7%, meaning that the prices should remain unchanged in the rest of this year in order to bring the annual inflation in line with the Bank’s forecast. Given the seasonal and other factors, this scenario seems quite unlikely. The unprocessed food prices that surged significantly over the last three months (from 8% to 31% y/y) have been the reason behind the elevated food component. In essence, the high level of volatility in food prices is one of the major obstacles against the process of disinflationary goals. A Central Bank study that covers the period between 2006-2009 shows that the volatility of monthly food price inflation in Turkey is 4 times of the EU-27, while this ratio goes up to 6 for the unprocessed food component, with Turkey having a higher volatility of monthly unprocessed food price inflation than each of the EU27 members. It should be noted that the volatility is two-sided and the inflation can fall as rapidly as it ascended. Nevertheless, recognizing that this would not happen all of a sudden, I revised my year-end CPI forecast to 7.7% from 7.2% due to the change in our food price assumptions. On the other hand, I continue to anticipate CPI easing to 6.0% by the end of 2011 with the help of the taming in food segment.
Contrary to the increase in the annual headline inflation, there were declines in the core indicators. The annual price change of the Central Bank’s favorite core indicator (excluding food, energy, gold, alcoholic beverages and tobacco), namely the “core-I” index, declined by a significant 1.2 pp m/m to 2.5%. While this is the sixth consecutive fall in annual core inflation, current level is its lowest level in the history of the series that started in 2003. Furthermore, the annual price change in services declined by 0.4 pp to 4.2%, again the lowest in the history of the series.
All in all, there is no doubt that the underlying inflation proceeds at a benign pace. Yet this does not change the fact that there is this disturbingly wide gap between the headline and the core. The Central Bank is also concerned with this issue by emphasizing the risk of jeopardy in pricing behavior. The Bank warns that they may hike earlier than planned, in case this risk materializes. On the other hand, the Central Bank seems quite comfortable here, as a recent CBRT working paper titled “A New Core Inflation Indicator for Turkey” concludes that ‘...when inflation deviates from core inflation, it converges back to the core inflation; but not the other way around.’ However, this does not necessarily mean that the headline CPI would converge to 2.5%. The empirical data show that even though there are cases where headline converges to the core, the two indices happen to meet somewhere in the middle following a significant decoupling.
Therefore, while the leading indicators warn against some revival in the economic activity going forward, it would unlikely ring any alarm bells in the Central Bank with such an encouraging underlying inflation trend. While this data is supportive of the already dovish stance of the Central Bank, we continue to expect the rate hikes to start in the last quarter of next year and amount to 100bps in 2011.
25 Ekim 2010 Pazartesi
Rebalancing Bargain...
Summary: Whether you name it the “currency wars” or the war between Asian reflection and U.S. deflation, the implication would be intensified financial stability risk for Turkey, where growth is already constrained by the depressed external demand. Turkey is among the countries that exacerbate the global imbalances, which is seen as the culprits of the wars. Instead of pushing forward with the reforms to address the structural deficit, Turkey has so far been more engaged in reducing risks regarding the deficit financing. The Central Bank has taken such measures and they will likely continue doing so in the upcoming period to curtail these risks.
The surprise rate hike from the Central Bank of China last week has raised speculation regarding the G-20 decisions to be shaped at their weekend meeting. Moreover, this tightening move from China induced the markets to deviate from their current trend and exacerbate the market volatility. Basically, what we see was the softening of EUR/$, accompanied with the stock market sell-off. The mentioned speculation is about a “grand bargain between the U.S. and China.” The bargain assumes that the Federal Reserve to be less aggressive in an expected second round of quantitative easing when the FOMC meets on November 3rd in return for China tightening monetary policy and letting their currency Yuan to appreciate at a faster pace. On the other hand, Martin Wolf in example, from Financial Times is in the camp that perceives the recent developments in the context of a war between Asian reflation and U.S. deflation. Wolf says the U.S. would win the war thanks to their ability to print unlimited amount of dollar which is the reserve currency (either by pushing inflation higher or appreciating currencies against dollar in the rest of the World). The first rate hike from China since end-2007 is also interpreted to be a pre-emptive move, hinting that the monetary policy tools, aside from the F/X policy are part of the arsenal now. All in all, it is believed that the countries in Asia would guard against the ultra loose monetary policy objective of the U.S. which would export inflation to Asia through asset price bubbles. The market has perceived this new battle to be a risk against asset prices and the risk appetite has lost some ground. It is difficult to argue which of the above theses is true. However, there is one thing certain that the World continues to suffer from the lingering malaise in the post global crisis environment. Whether you name it the “currency wars” or the war between Asian reflation and U.S. deflation, the implication seems to be intensified financial stability risk for Turkey, where growth is already constrained by the depressed external demand. The good news is that the Central Bank has already been underscoring these risks for a while and acting fast in launching measures to combat these risks.
Behind the wars lie the global imbalances (high current account surplus in Asia, high C/A deficit in the U.S.) which failed to be corrected by the crisis, while the decoupling between countries during the recovery has made the situation even worse. In that context, the issue of maintaining a strong, balanced and sustainable growth has also been discussed by Oliver Blanchard, IMF Economic Counselor, who emphasized the difficulty of reaching this goal and outlined two complex global rebalancing acts that are required. First, internal rebalancing, that is based on the private demand taking the lead again in developed countries and on the consolidation of fiscal balances that were ruined during crisis. The second aspect of rebalancing is external rebalancing, which includes many advanced countries, most notably the U.S., relying more on net exports and many emerging countries, most notably China, turning more to domestic demand. Blanchard says both of these balancing acts have been proceeding, albeit at a very slow pace.
Turkey is also among the countries that inflate the global imbalances with an estimated current account deficit of above 5% this year. In essence, both cyclical and structural factors play role in rapid expansion of the current account deficit in Turkey, which in that sense does not match the emerging market prototype having external surpluses on the back of their commodity or industrial goods exports. Nevertheless, instead of pushing forward with the reforms to address the structural deficit, Turkey has so far been more engaged in reducing risks regarding the deficit financing that has become more vulnerable recently.
The Central Bank’s decisions announced from September onwards are also in this category. In our previous posts, we mentioned about how the Turkish Central Bank describes the new conjuncture. The Central Bank had warned that the intensive capital flows into trusted and dynamic emerging market economies during this period underscore the risk of overheating, excess borrowing and emergence of asset bubbles in these economies, eventually pushing the current account deficit to levels that may jeopardize the financial stability. The Bank had also said that the Bank’s latest decisions (about required reserves and F/X purchase auctions) should be seen as a preparation in advance of the new conjuncture. The Central Bank continued to stress these risks in the MPC meeting held afterwards. In the last meeting, the Bank said ‘While not yet a significant concern regarding financial stability, the Committee has indicated that these developments support the implementation of the “exit strategy” measures.’ As we noted many times before, we expect these measures to continue, while the pace of domestic demand, in particular the domestic loan growth rate of the banking system, would be the key criteria in determining how fast the Central Bank would act. The weekly data for domestic loans have so far implied no change in the rate of expansion since the measures were taken.
In the Inflation Report due October 26th or in the 2011 Monetary and Exchange Rate Policy due December, the latest, the Central Bank would likely outline in more detail the roadmap about required reserves, which have become a more effective tool in curtailing macroeconomic and financial stability risks. This would help the banking sector to better visualize the future and hence fulfill their intermediary role between the monetary authority and the household and real sector in a more stable way.
The surprise rate hike from the Central Bank of China last week has raised speculation regarding the G-20 decisions to be shaped at their weekend meeting. Moreover, this tightening move from China induced the markets to deviate from their current trend and exacerbate the market volatility. Basically, what we see was the softening of EUR/$, accompanied with the stock market sell-off. The mentioned speculation is about a “grand bargain between the U.S. and China.” The bargain assumes that the Federal Reserve to be less aggressive in an expected second round of quantitative easing when the FOMC meets on November 3rd in return for China tightening monetary policy and letting their currency Yuan to appreciate at a faster pace. On the other hand, Martin Wolf in example, from Financial Times is in the camp that perceives the recent developments in the context of a war between Asian reflation and U.S. deflation. Wolf says the U.S. would win the war thanks to their ability to print unlimited amount of dollar which is the reserve currency (either by pushing inflation higher or appreciating currencies against dollar in the rest of the World). The first rate hike from China since end-2007 is also interpreted to be a pre-emptive move, hinting that the monetary policy tools, aside from the F/X policy are part of the arsenal now. All in all, it is believed that the countries in Asia would guard against the ultra loose monetary policy objective of the U.S. which would export inflation to Asia through asset price bubbles. The market has perceived this new battle to be a risk against asset prices and the risk appetite has lost some ground. It is difficult to argue which of the above theses is true. However, there is one thing certain that the World continues to suffer from the lingering malaise in the post global crisis environment. Whether you name it the “currency wars” or the war between Asian reflation and U.S. deflation, the implication seems to be intensified financial stability risk for Turkey, where growth is already constrained by the depressed external demand. The good news is that the Central Bank has already been underscoring these risks for a while and acting fast in launching measures to combat these risks.
Behind the wars lie the global imbalances (high current account surplus in Asia, high C/A deficit in the U.S.) which failed to be corrected by the crisis, while the decoupling between countries during the recovery has made the situation even worse. In that context, the issue of maintaining a strong, balanced and sustainable growth has also been discussed by Oliver Blanchard, IMF Economic Counselor, who emphasized the difficulty of reaching this goal and outlined two complex global rebalancing acts that are required. First, internal rebalancing, that is based on the private demand taking the lead again in developed countries and on the consolidation of fiscal balances that were ruined during crisis. The second aspect of rebalancing is external rebalancing, which includes many advanced countries, most notably the U.S., relying more on net exports and many emerging countries, most notably China, turning more to domestic demand. Blanchard says both of these balancing acts have been proceeding, albeit at a very slow pace.
Turkey is also among the countries that inflate the global imbalances with an estimated current account deficit of above 5% this year. In essence, both cyclical and structural factors play role in rapid expansion of the current account deficit in Turkey, which in that sense does not match the emerging market prototype having external surpluses on the back of their commodity or industrial goods exports. Nevertheless, instead of pushing forward with the reforms to address the structural deficit, Turkey has so far been more engaged in reducing risks regarding the deficit financing that has become more vulnerable recently.
The Central Bank’s decisions announced from September onwards are also in this category. In our previous posts, we mentioned about how the Turkish Central Bank describes the new conjuncture. The Central Bank had warned that the intensive capital flows into trusted and dynamic emerging market economies during this period underscore the risk of overheating, excess borrowing and emergence of asset bubbles in these economies, eventually pushing the current account deficit to levels that may jeopardize the financial stability. The Bank had also said that the Bank’s latest decisions (about required reserves and F/X purchase auctions) should be seen as a preparation in advance of the new conjuncture. The Central Bank continued to stress these risks in the MPC meeting held afterwards. In the last meeting, the Bank said ‘While not yet a significant concern regarding financial stability, the Committee has indicated that these developments support the implementation of the “exit strategy” measures.’ As we noted many times before, we expect these measures to continue, while the pace of domestic demand, in particular the domestic loan growth rate of the banking system, would be the key criteria in determining how fast the Central Bank would act. The weekly data for domestic loans have so far implied no change in the rate of expansion since the measures were taken.
In the Inflation Report due October 26th or in the 2011 Monetary and Exchange Rate Policy due December, the latest, the Central Bank would likely outline in more detail the roadmap about required reserves, which have become a more effective tool in curtailing macroeconomic and financial stability risks. This would help the banking sector to better visualize the future and hence fulfill their intermediary role between the monetary authority and the household and real sector in a more stable way.
18 Ekim 2010 Pazartesi
Bernanke fed QE2 hopes...
Summary: The expectations regarding more accommodative monetary policies in developed markets have recently found further support, with the measures against deflation being discussed more intensely. Despite the decoupling between developed and developing countries, the ultra-loose monetary policies in the former limit the central banks’ maneuvers in the latter. Therefore, many central banks choose to rely on monetary policy tools other than interest rates, such as decisions to prevent currency appreciation or macro prudential tools. Turkey also follows suit.
The news flow have continued to feed into the expectations that the Fed would start the second round of quantitative easing in November meeting and the anticipations of abundant global liquidity conditions have remained supportive of the financial markets. The FOMC minutes of the September 21st meeting was the last example. The FOMC members sounded very hopeless regarding the growth and inflation outlook, while most members favored more easing in monetary policy ‘before long’. Although the Committee members considered it unlikely that the economy would reenter a recession, many expressed concern that output growth, and the associated progress in reducing the level of unemployment, could be slow for some time. Participants noted a number of factors that were restraining growth, including low levels of household and business confidence, heightened risk aversion, and the still weak financial conditions of some households and small firms. Note that Fed has been uncomfortable with inflation being below levels consistent with the FOMC's dual mandate of maintaining full employment and price stability in the long run. While a minority in the Committee believes that additional accommodation would be warranted only if ‘the outlook worsened’ and ‘the odds of deflation increased materially’, many participants see a ‘too slow economic growth that would prevent satisfactory progress toward reducing the unemployment rate’ or ‘inflation surfacing below target levels’ as appropriate to provide additional monetary policy accommodation. In that context, a number of new alternative policy measures have been discussed at September FOMC meeting, as well. Among them ‘expanding long term bond purchases’ and ‘steps that would lift inflation expectations’ were the key focus areas. The minutes show that the members also discussed the best means to calibrate and implement additional asset purchases. Previously, we mentioned the key points of comments from New York Fed official Sack. Recall that his remarks hinted that the asset purchases would be in relatively continuous but smaller steps, rather than in infrequent but large increments.
Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were as follows: 1) the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments. 2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts. 3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential. 4) Providing information about the likely course of the balance sheet could be desirable. 5) Some flexibility should be incorporated into the program.
Last but not the least; we also want to touch on the monetary policy measures discussed by the Fed that would affect short term inflation expectations. As is known, real interest rate (that is the difference between nominal interest rates and expected inflation) is influential on total demand. Especially, the inflation expectations turn to be more important for monetary policy makers when policy rates are virtually zero. That is because; a decline in short-term inflation expectations increases short-term real interest rates, thereby damping aggregate demand. Conversely, in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy. Therefore, Fed seems to have started mulling on alternative strategies that would lift short term inflation expectations higher, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP. The last two strategies are new approaches for the central banking and there are no other countries that use them. Accordingly, these policy alternatives would unlikely be implemented in the short term.
While there are growing signs that the Fed would opt for more monetary easing, other Central Banks have also started to feel the pressure. Glancing at home, the outlook is quite mixed. The surprisingly strong industrial output in August triggered upgrades in growth forecasts, while the automotive sales and domestic demand in general have remained robust. These factors have the potential to put upward pressure on interest rates. On the other hand, the downside risk to external demand, the slowdown signals from leading economic activity indicators, TRY appreciation, the decline in bond yields and risk premiums, the impression of a tighter fiscal policy stance thanks to the Medium Term Program budget targets are all among the factors that would necessitate for lower policy rate or at least would urge for the maintenance of the current stance. The MPC meeting on October 14th was supposed to shed more light on how these developments would affect the Central Bank’s position. This meeting had an added importance since it was the last one to be held prior to the Inflation Report (where the Bank would update the inflation and output gap forecasts) due October 26th. The MPC decision did not involve much surprise and the statement indicated that the exit strategy would remain on course. After the meeting, the Central Bank also announced new decisions regarding the F/X market and open market operations. The Bank seemed to have slightly upgraded their assessment of the economic outlook in general. They said the economic activity continues to recover and domestic demand displays a relatively stronger outlook. In due course the Central Bank presumed headline inflation to be in a declining path, while core inflation was projected to remain consistent with medium term targets. From here, one may conclude that despite the decline in the core price inflation to as low as 3.7% in September, the Bank preferred to remain cautious due to the upside risks on headline CPI regarding the food price inflation. On the policy rate front, the Bank left their rhetoric untouched by reiterating that current levels would be maintained for some time and interest rate would remain low for a long period. The Bank seems to have preferred to wait for Inflation Report to describe the likely interest rate path more clearly. Meanwhile, the Bank also emphasized that the expectations of more accommodative monetary policies in developed economies which boost capital flows toward emerging markets and the accompanied decline in risk premiums, as well as the resulting appreciation of TRY and downside pressure on interest rates exacerbate upside risks to domestic demand and eventually underscore the threats against financial stability. In that concept, it is obvious that the Bank would continue relying on tools other than policy rate. The Bank continued to proceed with measures that would help normalization of the F/X, TRY and open market operations (the Bank abolished its intermediary function in the foreign exchange deposit market, ceased 3-month repo auctions, cut the O/N borrowing rates by an additional 50 bps and cancelled the provision of one-week funding to the primary dealers) and additional increase in TRY required reserve ratio should be expected soon.
The news flow have continued to feed into the expectations that the Fed would start the second round of quantitative easing in November meeting and the anticipations of abundant global liquidity conditions have remained supportive of the financial markets. The FOMC minutes of the September 21st meeting was the last example. The FOMC members sounded very hopeless regarding the growth and inflation outlook, while most members favored more easing in monetary policy ‘before long’. Although the Committee members considered it unlikely that the economy would reenter a recession, many expressed concern that output growth, and the associated progress in reducing the level of unemployment, could be slow for some time. Participants noted a number of factors that were restraining growth, including low levels of household and business confidence, heightened risk aversion, and the still weak financial conditions of some households and small firms. Note that Fed has been uncomfortable with inflation being below levels consistent with the FOMC's dual mandate of maintaining full employment and price stability in the long run. While a minority in the Committee believes that additional accommodation would be warranted only if ‘the outlook worsened’ and ‘the odds of deflation increased materially’, many participants see a ‘too slow economic growth that would prevent satisfactory progress toward reducing the unemployment rate’ or ‘inflation surfacing below target levels’ as appropriate to provide additional monetary policy accommodation. In that context, a number of new alternative policy measures have been discussed at September FOMC meeting, as well. Among them ‘expanding long term bond purchases’ and ‘steps that would lift inflation expectations’ were the key focus areas. The minutes show that the members also discussed the best means to calibrate and implement additional asset purchases. Previously, we mentioned the key points of comments from New York Fed official Sack. Recall that his remarks hinted that the asset purchases would be in relatively continuous but smaller steps, rather than in infrequent but large increments.
Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were as follows: 1) the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments. 2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts. 3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential. 4) Providing information about the likely course of the balance sheet could be desirable. 5) Some flexibility should be incorporated into the program.
Last but not the least; we also want to touch on the monetary policy measures discussed by the Fed that would affect short term inflation expectations. As is known, real interest rate (that is the difference between nominal interest rates and expected inflation) is influential on total demand. Especially, the inflation expectations turn to be more important for monetary policy makers when policy rates are virtually zero. That is because; a decline in short-term inflation expectations increases short-term real interest rates, thereby damping aggregate demand. Conversely, in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy. Therefore, Fed seems to have started mulling on alternative strategies that would lift short term inflation expectations higher, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP. The last two strategies are new approaches for the central banking and there are no other countries that use them. Accordingly, these policy alternatives would unlikely be implemented in the short term.
While there are growing signs that the Fed would opt for more monetary easing, other Central Banks have also started to feel the pressure. Glancing at home, the outlook is quite mixed. The surprisingly strong industrial output in August triggered upgrades in growth forecasts, while the automotive sales and domestic demand in general have remained robust. These factors have the potential to put upward pressure on interest rates. On the other hand, the downside risk to external demand, the slowdown signals from leading economic activity indicators, TRY appreciation, the decline in bond yields and risk premiums, the impression of a tighter fiscal policy stance thanks to the Medium Term Program budget targets are all among the factors that would necessitate for lower policy rate or at least would urge for the maintenance of the current stance. The MPC meeting on October 14th was supposed to shed more light on how these developments would affect the Central Bank’s position. This meeting had an added importance since it was the last one to be held prior to the Inflation Report (where the Bank would update the inflation and output gap forecasts) due October 26th. The MPC decision did not involve much surprise and the statement indicated that the exit strategy would remain on course. After the meeting, the Central Bank also announced new decisions regarding the F/X market and open market operations. The Bank seemed to have slightly upgraded their assessment of the economic outlook in general. They said the economic activity continues to recover and domestic demand displays a relatively stronger outlook. In due course the Central Bank presumed headline inflation to be in a declining path, while core inflation was projected to remain consistent with medium term targets. From here, one may conclude that despite the decline in the core price inflation to as low as 3.7% in September, the Bank preferred to remain cautious due to the upside risks on headline CPI regarding the food price inflation. On the policy rate front, the Bank left their rhetoric untouched by reiterating that current levels would be maintained for some time and interest rate would remain low for a long period. The Bank seems to have preferred to wait for Inflation Report to describe the likely interest rate path more clearly. Meanwhile, the Bank also emphasized that the expectations of more accommodative monetary policies in developed economies which boost capital flows toward emerging markets and the accompanied decline in risk premiums, as well as the resulting appreciation of TRY and downside pressure on interest rates exacerbate upside risks to domestic demand and eventually underscore the threats against financial stability. In that concept, it is obvious that the Bank would continue relying on tools other than policy rate. The Bank continued to proceed with measures that would help normalization of the F/X, TRY and open market operations (the Bank abolished its intermediary function in the foreign exchange deposit market, ceased 3-month repo auctions, cut the O/N borrowing rates by an additional 50 bps and cancelled the provision of one-week funding to the primary dealers) and additional increase in TRY required reserve ratio should be expected soon.
12 Ekim 2010 Salı
Bartenders Refill Punchbowl…
Summary: The financial markets, being convinced that a new phase of quantitative easing would be launched, have started to search for a new equilibrium. The ultra loose monetary policies in developed countries triggered intervention in F/X markets and other measures to discourage capital inflows in many countries, giving the impression of currency wars across the globe. The Central Bank has been prepared to take action to secure financial stability, bearing in mind that this new conjuncture may result in volatility in financial markets. It remains to be seen whether new measures for price stability would also be introduced.
The post-crisis economic backdrop seems to have entered into a new phase of unconventional monetary easing, or more specifically the second round of quantitative easing (QE2). This tool has been especially preferred by developed countries which experience slow economic recovery after the recession and who have already cut policy rates to rock-bottom levels. In September meeting, Fed put greater emphasis on deflation risk and has become the first Central Bank that signaled for expansion in its balance sheet. Moreover, the remarks by a number of Fed officials since then have further fueled into the expectations that Fed would launch QE2 as early as the November 3rd meeting. Japan also joined this camp by lowering the policy rate to 0.0-0.1% range, accompanied with additional asset purchase program. These decisions that would further boost already abundant global liquidity have started to drive the financial markets to a new equilibrium. The Fed’s relative position in terms of monetary policy stance has deteriorated due to their bias for ultra loose monetary policy, consequentially dragging US$ lower across all currencies. The 2-year U.S. Treasury yield slumped to a record low of 0.4%, with the market seeming more deeply convinced that the interest rates would remain low for an extended period. This has also formed the basis for growing appetite for riskier assets. Especially the stock markets across the globe and the emerging market assets in general have become the beneficiaries of this new environment, with the repercussions in Turkey being lower F/X basket and $/TRY, as well as tighter yields along the curve and record highs in stock market. The Central Bank names the key features of this new economic conjuncture as the ‘occurrence of the risks of overheating, excessive indebtness and emergence of asset bubbles as a result of intensive capital inflows towards reliable and dynamic emerging market economies, and the probability of elevated levels of current account deficit threatening financial stability.’ The Bank also says that the additional measures they have taken recently are preparation for the new economic situation, which would dominate the whole world in the upcoming period.
Note that the markets have got very much accustomed to the idea of additional expansion in Fed’s balance sheet (which has expanded to $2.3trn from $860bn prior to the crisis) so that they were not surprised to hear some Fed officials giving details regarding how QE2 would operate. A good example was the speech by Brian Sack from the NY Fed about “Managing the Federal Reserve's Balance Sheet" where he outlined five policy questions that could be considered in designing a purchase program. Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were:
1) Similar to the manner in which the FOMC has historically adjusted the federal funds rate, the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments.
2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts just was the case for the decisions regarding the federal funds target rate.
3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential.
4) Providing information about the likely course of the balance sheet could be desirable, similar to the case for federal funds rate.
5) Some flexibility should be incorporated into the program, providing some discretion to change course as market conditions evolve and as more is learned about the instrument.
Note that the ultimate goal of the QE2 is to change the yield curve and revive the economic activity through the banking sector. While doing this, Fed is likely to expand the balance sheet gradually and in small amounts, rather than a substantial and front-loaded approach of the earlier round of asset purchases. While the BoE is foreseen to mirror the steps of its peers BoJ and Fed, the implications of this new round of monetary easing on other Central Banks should be discussed as well. This may urge those Central Banks who have already moved forward with some tightening to give a second thought to their decisions. Moreover, the appreciation of emerging market currencies would potentially have favorable repercussions on inflation with some lag and that could create room for monetary easing maneuvers in some countries, considering also that the risk premiums would remain low in such environments. Ironically, going forward, macroprudential tools may be used more intensively for the sake of financial stability while at the same time a loose monetary policy stance may be adopted to address the price stability objective.
The key question would be whether Turkish Central Bank would also join this camp. Despite the jump in the headline CPI in September, core indices remained below the medium term targets. Moreover, the leading economic activity indicators hinted at some slowdown going forward. These were the developments that supported the Central Bank to at east keep the current monetary policy stance for a longer time. However, it is yet early to conclude whether the fresh developments would be enough to induce the Central Bank for a remarkably change in their baseline scenario that includes limited rate hikes in 2011. We will keep monitoring the signals regarding such a change.
The post-crisis economic backdrop seems to have entered into a new phase of unconventional monetary easing, or more specifically the second round of quantitative easing (QE2). This tool has been especially preferred by developed countries which experience slow economic recovery after the recession and who have already cut policy rates to rock-bottom levels. In September meeting, Fed put greater emphasis on deflation risk and has become the first Central Bank that signaled for expansion in its balance sheet. Moreover, the remarks by a number of Fed officials since then have further fueled into the expectations that Fed would launch QE2 as early as the November 3rd meeting. Japan also joined this camp by lowering the policy rate to 0.0-0.1% range, accompanied with additional asset purchase program. These decisions that would further boost already abundant global liquidity have started to drive the financial markets to a new equilibrium. The Fed’s relative position in terms of monetary policy stance has deteriorated due to their bias for ultra loose monetary policy, consequentially dragging US$ lower across all currencies. The 2-year U.S. Treasury yield slumped to a record low of 0.4%, with the market seeming more deeply convinced that the interest rates would remain low for an extended period. This has also formed the basis for growing appetite for riskier assets. Especially the stock markets across the globe and the emerging market assets in general have become the beneficiaries of this new environment, with the repercussions in Turkey being lower F/X basket and $/TRY, as well as tighter yields along the curve and record highs in stock market. The Central Bank names the key features of this new economic conjuncture as the ‘occurrence of the risks of overheating, excessive indebtness and emergence of asset bubbles as a result of intensive capital inflows towards reliable and dynamic emerging market economies, and the probability of elevated levels of current account deficit threatening financial stability.’ The Bank also says that the additional measures they have taken recently are preparation for the new economic situation, which would dominate the whole world in the upcoming period.
Note that the markets have got very much accustomed to the idea of additional expansion in Fed’s balance sheet (which has expanded to $2.3trn from $860bn prior to the crisis) so that they were not surprised to hear some Fed officials giving details regarding how QE2 would operate. A good example was the speech by Brian Sack from the NY Fed about “Managing the Federal Reserve's Balance Sheet" where he outlined five policy questions that could be considered in designing a purchase program. Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were:
1) Similar to the manner in which the FOMC has historically adjusted the federal funds rate, the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments.
2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts just was the case for the decisions regarding the federal funds target rate.
3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential.
4) Providing information about the likely course of the balance sheet could be desirable, similar to the case for federal funds rate.
5) Some flexibility should be incorporated into the program, providing some discretion to change course as market conditions evolve and as more is learned about the instrument.
Note that the ultimate goal of the QE2 is to change the yield curve and revive the economic activity through the banking sector. While doing this, Fed is likely to expand the balance sheet gradually and in small amounts, rather than a substantial and front-loaded approach of the earlier round of asset purchases. While the BoE is foreseen to mirror the steps of its peers BoJ and Fed, the implications of this new round of monetary easing on other Central Banks should be discussed as well. This may urge those Central Banks who have already moved forward with some tightening to give a second thought to their decisions. Moreover, the appreciation of emerging market currencies would potentially have favorable repercussions on inflation with some lag and that could create room for monetary easing maneuvers in some countries, considering also that the risk premiums would remain low in such environments. Ironically, going forward, macroprudential tools may be used more intensively for the sake of financial stability while at the same time a loose monetary policy stance may be adopted to address the price stability objective.
The key question would be whether Turkish Central Bank would also join this camp. Despite the jump in the headline CPI in September, core indices remained below the medium term targets. Moreover, the leading economic activity indicators hinted at some slowdown going forward. These were the developments that supported the Central Bank to at east keep the current monetary policy stance for a longer time. However, it is yet early to conclude whether the fresh developments would be enough to induce the Central Bank for a remarkably change in their baseline scenario that includes limited rate hikes in 2011. We will keep monitoring the signals regarding such a change.
4 Ekim 2010 Pazartesi
New Mission of CBT: Financial Stability
Summary: Lately the Central Bank has been putting a greater emphasis on financial stability. In order to fulfill this goal, they have started using the alternative monetary policy tools other than interest rate more effectively. Having already made some revisions about the RR, the Bank signals that the RR may also be employed as a tool to extend the maturities of deposits. The Central Bank also underlines that the cost associated with the accumulation of financial risks would be higher level of interest rates and therefore a more limited interest rate hike than normally expected may suffice provided that the macroprudential tools are put into force.
The repercussions of the alternative monetary policy tools started to be used by the Central Bank continue to be felt in the markets. Among last week’s decisions launched by the Central Bank, the removal of the interest paid on required reserves (RR) was the major shock to the markets, rather than the increase in the RR ratios. The Central Bank’s exit strategy had not mentioned such a change in regulation and therefore the decision should be considered as a surprise. The Central Bank said their aim is to use RR ratios more actively as a policy tool to mitigate the macroeconomic and financial risks. After all, it was obvious that the increase in the RR by itself would not be enough to limit the credit expansion, given the interest paid on TRY RR which is 80% of the Central Bank’s O/N borrowing rate. Moreover, the news that in order to extend the maturities of deposits the Central Bank may apply varying RR ratios depending on their maturities is a sign that the Central Bank would continue using this alternative policy tool more actively. In the meantime, the Central Bank’s emphasis on further possible reduction in the O/N borrowing rates hints that the Bank would keep utilizing liquidity management facilities more effectively. Having summarized the fresh developments regarding the monetary policy framework, we will now have a closer look into the “financial stability” concept that appears to be the reason behind the regeneration of alternative monetary policy tools, as well as the implications of this concept for the Central Bank’s monetary policy. The financial stability can be defined as avoiding or dispelling the financial system inadequacies and disruptions that could potentially have major distortions on the real economy. Recently, the Central Bank has been putting a special emphasis on this concept, as should be understood from the latest MPC meeting summary where the Bank said that “….global crisis has demonstrated the importance of central banks having an auxiliary financial stability mandate as well as the objective of price stability.” Accordingly, this adds another objective to the Bank’s current obligations of fighting inflation, as well as supporting growth and employment. It at the same time hints that the Central Bank anticipates this objective to become more widespread going forward. The CBRT Law says: “The primary objective of the Bank shall be to achieve and maintain price stability. The Bank shall determine on its own discretion the monetary policy that it shall implement and the monetary policy instruments that it is going to use in order to achieve and maintain price stability.“ Whereas, via the presentations recently made by Central Bank Governor, another mandate has been added and the Bank’s primary roles have been defined as follows: 1. To achieve price stability; 2. To take measures to enhance stability in the financial system; 3. To support the growth and employment policies of the government provided that it shall not be in confliction with the objective of price stability.
This new mandate would likely be included in the Central Bank Law as soon as there is a chance for such an amendment. On the other hand, there is another independent entity in Turkey, namely BRSA that has the responsibility of supervision of the financial system. Therefore, it seems that there may be problems associated with enlarging the authorization of the Central Bank, as was understood from BRSA Governor’s comments that came after the Central Bank’s decision to raise the RR.
Returning to the Central Bank’s financial stability mandate, the Bank defines primary objectives as given in the following lines. Therefore, following the Bank’s plans about applying varying RR ratios for deposits depending on their maturities, other steps associated with either of these items may also be expected going forward.
1. Debt Ratios: Use of more equity, less debt
2. Debt Maturities: Extending maturities of external borrowing and domestic deposits
3. FX Positions: Strengthening FX position of the public and the private sectors
4. Risk management practices: More effective management of financial risks by all agents in the economy
In another presentation, the Bank lists the macroprudential tools that can be used to achieve these objectives as follows: Reserve Requirements, Central Bank’s Liquidity Provision, Bank’s Capital Requirements, Banks’ Liquidity Requirements and Taxes.
The first two of these are the Central Bank’s responsibility, while the BRSA is authorized for the following two and the Finance Ministry has the control over the last tool. Therefore, institutions must cooperate in order to use these tools efficiently.
The graphs in the Central Bank’s mentioned presentation suggest that, financial stability curve would urge for a higher interest rate if there is positive output gap, while a lower interest rate would be implied by the curve when output gap turns negative. On the other hand, if macroprudential tools are employed to meet the financial stability objective, then the Taylor rule, which is the most common approach to determine the policy rate, would suggest lower interest rate when output gap is positive and higher interest rate when output gap is negative. A straightforward interpretation of this might be that in the period ahead when the output gap would be closed and eventually turn positive, the Central Bank is likely to keep the interest rate at a lower level than would be suggested by Taylor rule under normal circumstances, thanks to the macroprudential tools.
The repercussions of the alternative monetary policy tools started to be used by the Central Bank continue to be felt in the markets. Among last week’s decisions launched by the Central Bank, the removal of the interest paid on required reserves (RR) was the major shock to the markets, rather than the increase in the RR ratios. The Central Bank’s exit strategy had not mentioned such a change in regulation and therefore the decision should be considered as a surprise. The Central Bank said their aim is to use RR ratios more actively as a policy tool to mitigate the macroeconomic and financial risks. After all, it was obvious that the increase in the RR by itself would not be enough to limit the credit expansion, given the interest paid on TRY RR which is 80% of the Central Bank’s O/N borrowing rate. Moreover, the news that in order to extend the maturities of deposits the Central Bank may apply varying RR ratios depending on their maturities is a sign that the Central Bank would continue using this alternative policy tool more actively. In the meantime, the Central Bank’s emphasis on further possible reduction in the O/N borrowing rates hints that the Bank would keep utilizing liquidity management facilities more effectively. Having summarized the fresh developments regarding the monetary policy framework, we will now have a closer look into the “financial stability” concept that appears to be the reason behind the regeneration of alternative monetary policy tools, as well as the implications of this concept for the Central Bank’s monetary policy. The financial stability can be defined as avoiding or dispelling the financial system inadequacies and disruptions that could potentially have major distortions on the real economy. Recently, the Central Bank has been putting a special emphasis on this concept, as should be understood from the latest MPC meeting summary where the Bank said that “….global crisis has demonstrated the importance of central banks having an auxiliary financial stability mandate as well as the objective of price stability.” Accordingly, this adds another objective to the Bank’s current obligations of fighting inflation, as well as supporting growth and employment. It at the same time hints that the Central Bank anticipates this objective to become more widespread going forward. The CBRT Law says: “The primary objective of the Bank shall be to achieve and maintain price stability. The Bank shall determine on its own discretion the monetary policy that it shall implement and the monetary policy instruments that it is going to use in order to achieve and maintain price stability.“ Whereas, via the presentations recently made by Central Bank Governor, another mandate has been added and the Bank’s primary roles have been defined as follows: 1. To achieve price stability; 2. To take measures to enhance stability in the financial system; 3. To support the growth and employment policies of the government provided that it shall not be in confliction with the objective of price stability.
This new mandate would likely be included in the Central Bank Law as soon as there is a chance for such an amendment. On the other hand, there is another independent entity in Turkey, namely BRSA that has the responsibility of supervision of the financial system. Therefore, it seems that there may be problems associated with enlarging the authorization of the Central Bank, as was understood from BRSA Governor’s comments that came after the Central Bank’s decision to raise the RR.
Returning to the Central Bank’s financial stability mandate, the Bank defines primary objectives as given in the following lines. Therefore, following the Bank’s plans about applying varying RR ratios for deposits depending on their maturities, other steps associated with either of these items may also be expected going forward.
1. Debt Ratios: Use of more equity, less debt
2. Debt Maturities: Extending maturities of external borrowing and domestic deposits
3. FX Positions: Strengthening FX position of the public and the private sectors
4. Risk management practices: More effective management of financial risks by all agents in the economy
In another presentation, the Bank lists the macroprudential tools that can be used to achieve these objectives as follows: Reserve Requirements, Central Bank’s Liquidity Provision, Bank’s Capital Requirements, Banks’ Liquidity Requirements and Taxes.
The first two of these are the Central Bank’s responsibility, while the BRSA is authorized for the following two and the Finance Ministry has the control over the last tool. Therefore, institutions must cooperate in order to use these tools efficiently.
The graphs in the Central Bank’s mentioned presentation suggest that, financial stability curve would urge for a higher interest rate if there is positive output gap, while a lower interest rate would be implied by the curve when output gap turns negative. On the other hand, if macroprudential tools are employed to meet the financial stability objective, then the Taylor rule, which is the most common approach to determine the policy rate, would suggest lower interest rate when output gap is positive and higher interest rate when output gap is negative. A straightforward interpretation of this might be that in the period ahead when the output gap would be closed and eventually turn positive, the Central Bank is likely to keep the interest rate at a lower level than would be suggested by Taylor rule under normal circumstances, thanks to the macroprudential tools.
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