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How to stuff a Turkey

The Bank of Japan sets pulses racing while the US adds to Turkey’s economic woes by enacting fresh sanctions.

The past week has been a rollercoaster ride for Japanese Government Bonds (JGBs) – not something we get to say often! Yields rallied a “whopping” 5 basis points on Tuesday after the Bank of Japan (BoJ) vowed to keep rates low and cut its inflation forecast. However, they also tweaked their ‘Yield Curve Control (YCC)' policy by widening the band for longer-term JGB yields, allowing 10-year paper to trade in a yield range of between -0.2% and +0.2%. This led traders to test the BoJ’s resolve to defend its ultra-loose policy by pushing yields up for the sharpest single-day move in nearly two years. In the absence of the BoJ's heavy-handed intervention, it is likely JGB yields drift towards the new upper bound but in any case, we should expect more two-way price action inside the wider band over the coming months, which the BoJ should welcome as it moves towards the point where it starts normalising policy.

In an unprecedented move, the US government slapped sanctions on top Turkish officials over a jailed American pastor, further escalating a free-fall in the lira to its all-time low and a plunge in Turkish assets.

 

With Japan setting the floor for global core rates, the US leads the way in economic growth. US Q2 GDP hit a 4-year high of 4.1% and the Federal Reserve (Fed) reflected on strong economic growth in the latest FOMC meeting, thereby clearing the way for a September hike. For now, a backdrop of benign inflation and robust growth keeps the Fed on autopilot. Back at home, the Bank of England voted unanimously to raise its interest rate to 0.75%, looking through the temporary weakness in economic data.

On trade, markets are still at the mercy of Trump's tweets and The White House's goodwill. Market optimism on a potential re-start of trade negotiation between the US and China quickly evaporated as Trump’s administration upped the ante again this week by mulling over whether to hike tariffs from 10% to 25% on the next US$200 billion of Chinese goods. Furthermore, the US Congress joined the fray by passing a bill restricting China's military and technological advances. With NAFTA, it is not all rosy either as Canada is reported to have been excluded from tri-lateral negotiation while the US forges ahead in its deal-making with Mexico. For now, with trade wars having dominated much of the first half of 2018, investors are getting more accustomed to Trump's bravado on NAFTA and sabre-rattling of the two super-powers: China & US. No news is good news and bad news is perhaps just ‘not good news.’ Overall, we still maintain a constructive outlook on global growth.

While the broad emerging markets (EM) asset class has staged a modest recovery, recent idiosyncratic developments have sent Turkey into a tailspin. In an unprecedented move, the US government slapped sanctions on top Turkish officials over a jailed American pastor, further escalating a free-fall in the lira to its all-time low and a plunge in Turkish assets. Just last week, the Central Bank of Turkey (CBRT) also refused to raise its interest rate despite mounting inflation and a growing current account deficit. Lack of action from CBRT confirmed the market's worst fear that the central bank is indeed losing its independence; Erdogan calling interest rates ‘the mother of all evil’ a while ago had already put Turkey on shaky ground.

Away from macro themes, solid corporate earnings continued to be the theme over the week, notably with global growth proxy Caterpillar reporting better than expected results, affirming our positive view on the global economy. Revenues were up across all geographic regions with the company reporting strong order demand into 2019 as well as continued strength in end markets. Such anecdotal pieces of evidence should further allay concerns that the industrial cycle and broader economic activity have peaked.

News flow has certainly quietened down for the summer and while Turkey’s problems should be contained in our opinion – from an EM point of view – Turkey is far more important and possibly systemic than Argentina, particularly as IMF support for Erdogan, if needed, should not be taken for granted. It seems then that a turkey’s problems are not only confined to Thanksgiving. For now, this Turkey is ‘stuffed’.