As expected, the Bank of England (BoE) raised the rates by 25bp for the 12th time yesterday, and Governor Bailey left the door open for further rate hikes.
Bailey said that the lagging effects of the past rate hikes will weigh more on the economy in the coming quarters, that the BoE expects inflation to fall quickly this year, but reckoned that ‘inflation remains too high’ and that ‘repeated surprises’ pointed to the resilience of the economy and added to price pressures. As a result, the BoE will ‘stay the course’ to bring it down with further rate increases, he said.
British policymakers also made the biggest upgrade to their growth projections since the BoE gained independence since1997 – added Bloomberg.
Cable fell, and tipped a toe below the 1.25 mark, but the selloff was mostly driven by a broadly stronger US dollar.
Even though the US PPI data came in softer than expected, and US jobless claims reached the highest since October 2021 and PacWest slumped 22% after announcing that its deposits fell nearly 10% last week, and the US 2-year yield fell – all these factors normally being bearish for the dollar -, the US dollar jumped above a two-month bearish trend top.
Was yesterday’s move just a flight to safety, is it sustainable?
Looking at the EURUSD chart, it looks like the failure to clear the 1.10/1.11 offers now leads to a toppish sentiment, and that we could see a further downside correction in the EURUSD before a rebound to bring us to the 1.12 medium term target area.
In equities, the S&P500 was little changed yesterday, the S&P500 was slightly downbeat on renewed bank selloff, but Nasdaq100 extended gains to fresh highs since last summer. The falling yields clearly boost appetite in Big Tech stocks.
Decision time for Turkey
In Turkey, the BIST100 rallied almost 8% yesterday, as Muhammer Ince, one of the candidates to the presidential election, withdrew from the race, a day after he denied the ‘authenticity of an alleged sex tape and claims that he took bribes to run for president and split the opposition vote’.
His votes will still count – because there is also a parliamentary election happening simultaneously, but Mr Ince leaving the presidential race ramps up the chances for a defeat for the running President Erdogan, although Ince didn’t favour a candidate when he retreated.
On the currency front, the USDTRY continues gently to push higher.
Note that despite the ultra-lose monetary policy, abnormally low interest rates and deeply negative real rates, a massive FX intervention program from the Central Bank of Turkey kept the Turkish lira at levels significantly above the fair market value against major currencies.
It is a timebomb ready to explode in any misstep.
And a misstep could be an eventual Erdogan defeat – which would smash the castle of cards.
Right now, the actual President Erdogan’s defeat is being priced in as the base case scenario. No one knows what that means for the lira, but if the lira is left to move free, it would certainly face a significant devaluation.
In the base case scenario, the formation of a new government is expected to end Turkey’s ultra-loose monetary policy, halt heavy FX intervention, and readjust interest rates significantly higher to restore an understandable and orthodox monetary policy. In this case, not only that we would see a wild volatility in lira which could send the USDTRY all the way up to the 35/45 range, but we would also see Turkish policy rate lifted to 40/45% in the months following the election to match the official inflation level, while inflation would pop higher due to a potentially devastating devaluation in the lira.
Elsewhere, the Turkish equities would jump, not because investors are happy with higher rates, but because the valuation of the companies should also readjust to a new exchange rate – a significantly more expensive US dollar, hence a significantly higher valuation for Turkish stocks in terms of Turkish liras.
On a personal note, for me and my generation who have never seen Turkey ruled by anyone else than Mr. Erdogan, and any government other than his AKP party, the shock of a change would go well beyond what we could see in the markets.
