Natalia Gurushina, Chief Economist, Emerging Markets Fixed Income Strategy
August 06, 2020
Turkey’s meltdown continued this morning as the market believes the current policy framework is not sustainable. Two more EM central banks stayed on hold, keeping their remaining powder dry.
The Turkish lira meltdown intensified this morning, with the currency slipping by 357bps vs. U.S. Dollar (according to Bloomberg LP, as of 10:05am ET). The Turkish stock market and rates are selling off in sympathy and in the anticipation of potential policy actions, some of which might be hard to stomach. The chart below illustrates Turkey’s key problem (it also explains our “cornered” headline) – the central bank wasted too much of its international reserves on futile currency interventions, and its ability to continue “business as usual” is now severely limited. An orthodox policy prescription would be to let the currency go and (credibly) hike the policy rate. You might ask – hiking during the COVID crisis? Yes – Kazakhstan did exactly the same when its currency came under pressure in early March (from 9.25% to 12%), and this credible move paved the way for subsequent rate cuts (the policy rate is now at 9%). An alternative might be more controls, which is hardly optimal.
Two more EM central banks stayed on hold today – keeping the remaining powder dry and evaluating whether the recovery has legs. The Czech central bank’s decision was expected –the policy rate is already very low (0.25%), and inflation surprised to the upside recently. India’s unanimous decision was surprising, as the growth outlook remains uncertain. But the central bank’s emphasis on keeping inflation within the target was reassuring (credibility-wise).
Mexico’s gross fixed investments showed no signs of life in May – yearly contraction actually deepened to -39.7%. This is not a good sign as regards domestic demand, and invites more questions whether the government’s tight fiscal stance is justified. The latest headlines that authorities might reconsider opening the energy sector to foreign companies after 2021 point to major structural issues that can keep investments depressed for quite some time.
Chart at a Glance: Turkey – No More Room For “Business As Usual” Policies
Source: VanEck Research; BIS; Bloomberg LP
IMPORTANT DEFINITIONS & DISCLOSURES
PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments.; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.
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