The economic freakshow that is Erdoganomics is dead, if only for a few months…
The Turkish lira, which until today was the worst performing currency of 2023, exploded higher amid a massive short squeeze, after the Turkish central bank unexpectedly raised its benchmark interest rate much more than expected, in the first sign that a new lineup of monetary officials favors more aggressive moves to curb inflation running near 50%, and a stern rebuke to Erdogan’s long-running bizarro conviction that Turkey will keep rates lower in a bid to contain inflation (also known as Erdoganomics).
The Monetary Policy Committee, under new Governor Hafize Gaye Erkan, who previously was a co-CEO of the failed First Republic bank, raised the rate to 25%, up from 17.5% and far above survey expectations of a 20% hike. It was the MPC’s first decision since three new deputy governors were appointed late last month. They included a former adviser to the Federal Reserve Bank of New York and the ex-chief economist at one of Turkey’s biggest private lenders.
Erkan, appointed in June, has begun to end Turkey’s era of ultra-low borrowing costs previously favored by Erdogan.
While the rate remains well below the level of (hyper)inflation in Turkey, it’s the third straight hike since President Recep Tayyip Erdogan won reelection in May and pledged more orthodox policies for an economy foreign investors have fled in recent years.
Even with the recent hikes, many investors still think the central bank is still being too timid. They cite the fact inflation-adjusted interest rates remain well in negative territory as evidence of that. Turkey’s real rates are among the lowest in the world.
“The pace of policy tightening over recent months has disappointed market expectations,” ING Bank NV said ahead of Thursday’s decision, although today’s move may suggest the central bank is finally trying to catch up to real rates.
According to Bloomberg, Erkan’s approach poses significant risks for the credibility of the central bank, especially after it sharply raised its own inflation forecasts last month. The governor said price growth won’t peak until the second quarter of next year, but showed little willingness to raise policy rates much faster.
While Turkish rates should be much higher, the central bank’s latest regulation took aim at a government-backed savings program that protects account holders from any weakening of the lira. Officials now want them to convert to normal lira accounts. The new rules amount to a “stealth rate hike” and follow an earlier decision to raise banks’ reserve requirements that could in effect mean an additional 40 basis points of tightening, according to Bloomberg Economics.
On Sunday, the central bank began rolling the growing and costly scheme that protects lira deposits from FX depreciation, marking another move toward more orthodox policies following a shift toward interest rate hikes. The central bank said in the early hours on Sunday that it lifted targets applied to banks for certain levels of conversions of foreign-exchange deposits to the lira-protection scheme, known as KKM.
“The new measures will likely lead to higher rates on lira deposits,” Goldman Sachs Group Inc. analysts Clemens Grafe and Basak Edizgil said in a report. But “with the gap between deposit rates and the policy rate widening again, there is a risk of renewed dollarization or funds being withdrawn.”
In a reversal, the central bank now wants lenders to set a new goal of transitioning KKM accounts into regular lira accounts, in part by dissuading companies and individuals from renewing the KKM accounts.
According to a separate decree in the Official Gazette, the central bank also raised lenders’ reserve requirement ratios for FX deposits, further nudging customers into regular lira accounts.
Ahead of the rate decision, Citigroup cut the lira in its model portfolio after the government’s steps to reduce the size of foreign currency protected deposits. Citi said to go long USDTRY at 27.16 (via 3m forwards), with a target 32, stop 25.
“In light of the macro prudential measures taken by the CBT over the weekend to reduce the size of currency protected deposits, we think the timing is now suitable for re-entering this trade,” strategists Bhumika Gupta and Luis E Costa wrote in a note.
“MPC is also scheduled this week, and the consensus expectation is for a hike to 20% policy rate, from the current 17.5%. We see some risk that markets may be disappointed again, given the new Governor’s track record so far with respect to the magnitude of rate increases” Citi added.
In the end, she did indeed surprise, but on the other side, with a rate hike that was bigger than expected. The problem, of course, is that this has been tried before in Turkey, and every time there is a sharp rate hike, the economy eventually grinds to a halt, culminating with Erdogan firing the central bank head and appointing another puppet. To be sure, this time will be no different, but for now at least, the Lira is enjoying a huge short squeeze, with the USDTRY tumbling as much as 6%…
… the currency’s second largest squeeze in history, second only to the Dec 20, 2021 short massacre, when Erdogan fired a bazooka at lira shorts.
The move lasted a few months before the currency tumbled to new all time lows.