In the four weeks since China shifted to a new currency regime, the pressure on emerging markets and commodity currencies has been both palpable and persistent.
The possibility (however unlikely) that the Fed might make a “policy error” this month by hiking rates and accelerating outflows from EMs has only made the situation worse as has the growing realization that China’s economy may be decelerating faster than even the most pessimistic observers had suspected.
And there are of course idiosyncratic, country-specific factors such as the political turmoil in Turkey, Malaysia, and Brazil and the disconnect between the ruble and the Kazakh tenge, with the latter having finally forced Kazakhstan to move to a free float last month as the yuan devaluation was the straw that broke the camel’s back for central Asia’s largest energy exporter who was already suffering from a severe reduction in trade competitiveness thanks to the tenge’s relative overvaluation.
After regaining its footing, the tenge has hit the skids again, with Monday marking the seventh consecutive day of losses.
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On Friday, Sabit Khakimzhanov, head of research at Halyk Finance, told Bloomberg [12] that with tax payments in the rearview, the tenge re-entered the crosshairs:
Local companies accumulated the currency for tax payments. Now that the tax payments are over and the government is transferring cash to local government accounts and to pay civil servants’ salaries, there are more tenge in circulation, which is pushing the price down.
On Monday, with the tenge plunging by nearly 8%, Khakimzhanov says rates are simply too low in Kazakhstan to take the pressure off. From 12%, rates would need to rise by at least 400 bps to change the market’s perception another analyst contends. Here’s Bloomberg again [13]:
The central bank interest rate is “too low,” Sabit Khakimzhanov, head of research at Halyk Finance, a unit of the country’s second-largest lender by assets, said via phone. “If interest rates stay so low, the weakening of the tenge will continue and we will leapfrog Russia.”
Contrast that with comments out of Citi earlier this month after the NBK introduced the new base rate: "The 12% base rate looks elevated against the backdrop of below-target inflation, but is consistent with NBK’s medium-term outlook."
In any event, one country where rates are almost certainly too low given the confluence of factors weighing on the currency is Turkey. The country’s central bank had an opportunity to stem the lira’s decline last month, but balked, instead insisting that Turkey would not hike until the Fed moves. That, combined with a poorly communicated strategy regarding how the country plans to react to DM policy normalization, rattled the market significantly and the lira’s slide continued unabated with political upheaval and escalating violence serving to exacerbate an already precarious FX situation.
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For their part, Citi is "puzzled by the CBT’s ever-growing tolerance for a weaker lira":
All in all, we believe that the CBT doesn’t have the luxury to carry out a gradual experiment under current circumstances. Our findings suggest that conditions are ripe for a rate hike and that, under current conditions, the CBT’s single policy should be around 11% or even higher. We believe that weak capital inflows and the challenging inflation outlook will test the CBT’s resolve to keep its wait-and-see approach. It is, however, clear to us that delaying a rate hike is likely to require an even sharper response later – a painful experience that the markets endured at least twice during the CBT’s bumpy unorthodox journey.
The pain continued on Monday as the lira hit a new record low in the wake of Prime Minister Ahmet Davutoglu's re-election as AKP chairman [15] at a party conference which also saw Erdogan loyalists named to executive committees, underscoring the strongman’s iron grip on Turkish politics. In a hilariously absurd piece of agitprop, Davutoglu said that "suddenly, the PKK, the DHKP-C, the Islamic State, with their foreign support, pressed the button to destroy all of the accomplishments of the AK Party's 12, 13 years in power.”
“While they are taking action to achieve their evil aims, the AK Party cadres are taking action for a new democracy on Nov. 1,” Davutoglu added. That, of course, couldn’t be further from the truth. It was in fact Erdogan who “suddenly” decided to “press the button” that sent the country careening into chaos and the weak lira is a reflection of that.
Meanwhile, the central bank has remained obstinate, choosing to eschew an emergency rate hike even as market calls for action have grown quite loud. Here’s a bit of color from Nomura (via Bloomberg):
Turkish central bank’s reluctance to raise interest rates before Nov. 1 general election means the lira “might end up taking the strain,” Nomura’s Tim Ash says by e-mail.
- "The central bank will only look to move if the TRY underperforms its EM peers, and ends up appearing the EMFX front line. Today, that appears to be the case’’
- If Fitch downgrades Turkey, central bank might be forced to repeat its emergency rate hike of Jan. 2014 to try and stem losses in the lira - “bad for growth, and not really helping the AKP’s re-election chances”
- AKP’s leadership convention over weekend shows President Recep Tayyip Erdogan retains his grip over the party, “and the future of Babacan, Simsek, et al is unclear”
- "Turkish markets will remain under pressure now until re-run elections, and some resolution on the domestic political front’’
Moving away from the specifics, it's important to reiterate that these are precisely the types of fragile situations which make it extraordinarily difficult for the Fed to embark on a rate hike cycle.
After seven years, ZIRP has become the norm and unconventional monetary policy has become not only conventional, but expected. In other words, there's a certain degree to which the "normalization" of Fed policy is actually a move towards something that's very abnormal in the post-crisis world. Just as we would suspect that ZIRP and trillions in QE would have a dramatic effect (if only on asset prices and flows) when suddenly brought to bear on markets which had never seen such a vast experiment in monetary insanity, so too should we expect the rollback of those policies to have an equally dramatic (but now inverse) effect on markets which have spent the better part of a decade under the new normal.
