In Turkey, ‘History Is Now Going In Reverse’

You can have your theories, but Turkey’s Recep Tayyip Erdogan “cannot be on the same path with those who defend interest.”

That’s a quote from a speech Erdogan delivered in parliament earlier this week. If you don’t emit a wry chuckle, you’re not apprised of the situation.

Headed into Thursday’s rate decision, CBT governor Sahap Kavcioglu delivered 300bps worth of rate cuts over two meetings in an effort to placate Erdogan, whose “unorthodox” (an absurd euphemism) views on rates, inflation and the currency are the stuff of legend. Kavcioglu replaced the hawkish Naci Agbal in March, much to the chagrin of markets.

Kavcioglu kept rates unchanged for his first five meetings, but Erdogan’s insistence on lowering borrowing costs while simultaneously bringing down inflation meant it was just a matter of time before the central bank was forced into another easing cycle on the wildly ridiculous premise that easing policy would ameliorate price pressures in an emerging market which has lost virtually all credibility when it comes to central bank independence.

On Thursday, Kavcioglu cut rates again. The 100bps move was in line with market expectations, but that’s largely irrelevant. What matters is that Erdogan has now succeeded in driving real rates to almost -5% (figure below).

Remember, for emerging markets lacking sufficient monetary sovereignty, orthodoxy does matter. So, what you see in the chart is a problem.

Headline inflation ran at 19.89% last month. In September, Kavcioglu shifted the bank’s focus to core inflation, which strips out food, opening the door to the current easing cycle.

But the core print for October was 16.8%, which means that even if you use Kavcioglu’s preferred gauge, real rates are still negative. Thursday’s cut took the policy rate down to 15% (figure below).

“The Committee expects that the transitory effects of supply-side factors and other factors beyond monetary policy’s control on price increases will persist through the first half of 2022,” CBT said Thursday, adding that the bank will “consider to complete the use of the limited room implied by these factors in December.”

Conceivably, you could argue that language suggests Kavcioglu will tread cautiously going forward, but that’s a very generous interpretation. In fact, you could well read it as suggesting another cut is just a month away.

The lira is in a death spiral. It fell a ninth day Thursday to a record low beyond 11 (figure below).

Erdogan exacerbated the situation last month when he threatened to expel western diplomats (blue dot).

The lira is the world’s worst performing EM currency in 2021. It goes without saying that any dollar appreciation which may accompany expectations for tighter Fed policy would make the situation worse, as would any fresh geopolitical tensions Erdogan manages to stoke.

“There’s very little value in going through the details of the CBT statement,” TD’s Cristian Maggio sighed. “[It’s] full of disinflationary rhetoric that, in our opinion, is only meant to justify monetary easing at a time that rates should be hiked instead.”

Masaki Kondo, a Tokyo-based blogger for Bloomberg, shared an anecdote. “Over the weekend, my father told a story of his acquaintance, who had bought a large sum of Turkish lira funds,” Kondo wrote. “The friend built a new home and had been relying on high interest from the investment to pay down the mortgage until the rapid depreciation in the Turkish currency ruined this quasi-carry trade.” The lira, you’ll recall, is popular among Japanese retail investors.

Assuming Kavcioglu eases further (say, another 100bps) and inflation keeps rising, real rates in Turkey could well fall to negative 800bps over the next several months.

Should that outcome materialize, real rates would be “way lower than most levels recorded over the past two decades,” TD’s Maggio went on to write Thursday, adding that the last time real rates were lower than that was in March of 2002, “paradoxically when the AKP and Erdogan came to power the first time, and Turkey started slowly healing from the deep damages of the hyperinflation period that preceded.”

“It would seem like history is now going in reverse,” Maggio said.

Erdogan is undaunted. On Wednesday, he pledged to “lift the interest rate burden from citizens.”