Frog in the kitchen, elephant in the living room
Although the global liquidity glut has come to an end, the slackness it has caused remains. Tepid water is no use to the frog when the water has already started boiling.
Historically low volatility and high risk appetite felt like an “endless love story” that took asset prices in the markets to their peaks.
International markets closed with sharp falls last week as the players became more convinced of a rapid rise in interest rates after the U.S. high wage increase and employment data was released.
On the other hand, developments in Turkey emerge as a joke. Despite a slump in stocks and rise in rates in the international markets, exercises on “how to cut interest rates” despite high inflation have kicked off at the national level.
In the last 10 days the yield on the 10-year U.S. Treasuries jumped 25 basis points to 2.9 percent, the highest rate since Jan. 2014. Let me remind you that in Dec. 2013 the U.S. bond yields reached 3 percent after then Federal Reserve Governor Ben Bernanke made a speech hinting at the end of the loose monetary policy. Now we are close to that point again.
While efforts to lower interest rates re-emerge, key inflation indicators based on 2003 indexes are at their worst levels. Shocks of food and energy prices are understandable but core inflation rate is also at its worst level in 15 years. Moreover, disruption of price setting behavior is in a similar position.
In January, the inflation rate showed a decline on an annual basis. This was caused by the base effect. Since the index had seen rises in Jan. 2017, the annual inflation rate decreased from 11.9 percent to 10.3 percent.
An important question is this: Do the declared inflation data of January imply a prospective decline? My answer is no.
First of all, the core inflation rate of January is still close to the highest levels of the same month in the last 10 years and is above the average. An annual increase is stable at the level of 12 percent.
When it comes to the increase of producer prices, a one-percent rise in January is not low. It is lower than last year’s rate but it was the slump in energy prices that dragged it down. And it is probably a one-off. This argument is confirmed by the 1.6 increase in manufacturing industry prices, the “admiral” of all producer prices, in January. This is higher than the December rates. The pressure on production costs continues.
Intermediate good prices, the main element of production inputs, rose 1.9 percent on a monthly basis. It is higher than the previous month but slightly lower than the last three-month average. Similarly durable goods prices have risen 2 percent and capital goods prices have risen 2.3 percent. These are very high increases for a country whose annual inflation target is 5 percent. It is hard to believe that the industrialists could undertake these hikes not to increase the final product prices.
There cannot be a “developed country” on earth with production costs rising 15-20 percent annually and with a core inflation trend of 10 percent. Even if such a country existed, the conversation would focus on how to find a remedy for the inflation problem, not on how to cut the interest rates.
Not just food prices
Sadly, “throwing the ball out of bounds” has been a national sport in Turkey. It is like focusing only on food price increases in the kitchen while the significant core inflation rate, which excludes food and energy prices, resembles an elephant sitting in the middle of the living room. Maybe even that would be alright if the necessary steps to cure the problem were taken.
As “food committees” gather, every so often the costs of cutting-rates sessions are forgotten. Take the Yavuz Sultan Selim Bridge. There you see how ill-planned infrastructure projects create extra costs as they cause endogeneity.
In Istanbul, which has become a megalopolis, this effect can be observed on distribution channels. Transportation and distribution or logistics come first. To limit public money allocated to the ill-planned bridge, all trucks and vans crossing the Bosphorus have been obliged to use this new bridge, which is 2.5 times more expensive. Transportation costs jumped, especially for foods.
Back to the starting point. While Ankara is making efforts to cut interest rates, households and companies are buying foreign currency to hedge against inflation. Exchange rates are rising. Costs are rising. Bridge tolls, priced on US Dollars value, are rising. Food prices are rising.
On top of that, world developments tend to increase the value of foreign currencies on which we are highly dependent. It is clear that changing the external conjuncture will make things more difficult. So what’s the point in turning the heat of the cooker?