Inflation declines for first time since crisis

Published 08.07.2014 00:03

The Central Bank of Turkey's release of CPI data Thursday showed what appears to be inflation topping out. Year-over-year core inflation was down to 9.16 percent, down 50 basis points from its peak in May. Consensus estimates had inflation dropping 86 basis points, however, the more modest drop was welcomed by financial markets, just the same, as the markets continued to preserve their gains for the year ahead of the upcoming presidential election.

The benchmark BIST-100 index rallied to 78,302 points at midday Monday, up nearly 1,700 points or 2.2 percent since the announcement of the inflation numbers, Thursday morning. Reacting to the first decline in inflation since the Dec. 17 crisis, Turkish equity markets were up across the board. The announcement by the U.S. Federal Reserve later in the day Thursday showed a recovering U.S. economy as unemployment hit multiyear lows of 6.1 percent. With April and May data also being revised upward, this was great news for the U.S. economy as markets in New York rallied in response. Although many speculate that this may mean a tapering of bond-buying by the Fed will accelerate and interest rates may soon begin to rise, many ignore the participation rate in the employment market by workers. The participation in the job-market rate continues to be 62.8 percent, the lowest it has been since President Carter was in the White House.

I predict Fed Chairman Janet Yellen will point to this rate as being far below the 66 percent level, where it stood before the Great Recession crisis of 2008, in arguing that any rate increases would be premature. "Should Yellen increase rates ahead of schedule, emerging markets would suffer. Any rate cut at this point would force fixed income markets across the emerging markets of the world to face sell-offs and this would devastate governments trying to raise inexpensive funding," noted famed Turkish "Bond-King" Emrah Ahi from his offices in Istanbul. "The long-end bond markets seem to have peaked and I expect a sell-off at the first signal of the imminent U.S. interest rate hike," he continued.

Fixed income instruments trading in Istanbul saw modest profit-taking with the benchmark two-year issuance's yield rise to 8.22 percent from its level of 8.09 percent where it had traded one week ago. Similarly, the long-end 10-year bonds saw their yield rise to 8.84 percent from 8.74 as their prices declined in kind.

Currency markets were stable as the Turkish lira traded at TL 2.13 to the U.S. dollar, down TL .01 from its previous level of TL 2.12 last Monday. The CDS market was also stable as credit default swaps, or insurance against political and economic uncertainty, traded at 1.79 percent, down 2 percent from their 1.75 level where they traded last week.

The Central Registry Agency's (MKK) "Foreign Participation in Turkish Equity Markets index" was down midday Monday to 63.47 percent. This is a modest decline of 0.23 percent in the last week as foreign investors may continue to be wary of the ongoing conflict in Iraq and its potential to draw its neighbors into any armed conflict.

The advance of ISIS into central Iraq has entered its fourth-week as the central government in Baghdad is beginning to respond to the ISIS fighters, aided in large part by the Kurdistan Regional Government's "peshmerga" fighters putting pressure on ISIS from the north. Any sustained fighting in Iraq would be bad news for financial markets across the region with uncertainty looming heavily over the oil-rich warweary country.

Turkey continues to prepare for the upcoming presidential election with Prime Minister Recep Tayyip Erdoğan leading in polls ahead of joint-opposition candidate Ekmeleddin İhsanoğlu. The two candidates are joined by HDP party candidate Selahattin Demirtas, the self-proclaimed voice of the Kurdish minority in the country. Barring an outright victory by the prime minister in the first round of voting, Demirtas' supporters would fall behind Erdoğan in a runoff election, making his victory a foregone conclusion at this point. Any surprise here would punish financial markets, easily spooked by political uncertainty.

Look for equity markets to rally ahead of the presidential election as polls begin to show an Erdoğan victory, while fixed income markets may see profit-taking unless the FED explicitly comments on delaying any interest rate hikes.

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