The party is over, but central bank still serving
The reaction of Turkish markets to U.S. data right before the end of last week clearly illustrates how the fate of Turkish assets and the economy are tied to the world’s largest economy.
The increase in U.S. July non-farm payrolls turned out to be less than expected on Aug. 2, hinting that the American economy was not recovering as fast as expected. The data contradicted upbeat economic indicators on second-quarter growth and manufacturing activity earlier in the week. Turkish stocks rallied, government bond interest rates fell and the Turkish Lira strengthened.
Strong U.S. data mean that the Federal Reserve (Fed) could start exiting its quantitative easing (QE) program earlier than expected. While the Fed will not suddenly stop its current purchase of $85 billion of bonds every month, its chairman, Ben Bernanke, said in June that it would likely begin scaling the program back later this year.
This would mean an end to the money flowing into emerging markets. Countries like Turkey, which are extremely dependent on capital flows, would feel the most pain. This is why even hopes of a delay to the start of this “tapering” could boost Turkish markets, as was the case Friday afternoon.
But Bernanke also said in June that the Fed would end its bond purchases around the middle of 2014, at which time unemployment would be around 7 percent. Friday’s data also revealed that unemployment fell to 7.4 percent in July from 7.6 percent the month before.
Moreover, as Deutsche Bank economists highlight, “there are decent arguments that endless QE should end because of too easy financial conditions and insufficient volatility.” The bottom line is that the Fed’s easy money policy will conclude soon, but it is actually more than that: With the end of QE, the global liquidity flush of the last decade will come to an end for good.
Turkey was one of the countries that benefited most from this decade. Having achieved macroeconomic stability after the 2001 crisis, it was able to attract huge capital flows, which could not resist the lure of relatively higher interest rates. Now that the party is all but over, you’d expect the government to take precautions.
Last week’s economic data illustrated why they are reluctant to. The fall in purchasing managers’ and CNBC-e consumer confidence indices in July as well as the weak growth in imports in June all show that economic recovery is yet to gain traction. Markets may be too optimistic in their expectations of 3.5 percent growth for this year.
That’s where independent central banks come in, but Gov. Erdem Başçı explicitly stated, during the release of the Central Bank’s latest Inflation Report, that the policy rate would remain fixed as long as the Fed kept its own policy rate fixed. He also hinted that the interest rate corridor would not be broadened further for now.
Central banks are supposed to take away the punch bowl just as the party gets going. The Central Bank of Turkey would like to keep us drunk so that we do not remember the crash.