Central bank's rate cut nothing to worry about

Turkish financial markets responded positively to the first interest rate cut to come out of Ankara in over a year. The Central Bank of the Republic of Turkey's (CBRT) Monetary Policy Committee moved to cut the overnight lending rate by 25 basis points from 10.50 to 10.25 on the heels of European Central Bank (ECB) easing. In recent weeks, policymakers at the ECB have reiterated their intent to continue easing, including an increase in their bond buy-back program - ratcheting up the monthly purchase amount by 20 billion euros to 80 billion euros.

Turkey's interest rate cut followed a 30 percent drop in crude oil prices since the last interest rate cut. A decrease in the price of gasoline helped curb inflation in Turkey, as Turkey's gasoline prices are one of the highest globally. With the U.S. Federal Reserve (Fed) signaling a delay in any further rate hikes for the next two meetings, the CBRT took this opportunity to cut rates. While many economists had predicted a rate cut might be premature for this economy, both the benchmark equity index and the benchmark bond issue actually gained strength following the announcement. The benchmark two-year government bond traded under 10 percent Monday, trading at its lowest levels since November. Similarly the BIST 100 equity index currently trades near the highs of the year albeit down 2.5 percent from the peak. The BIST 100 is still currently up over 13 percent for the year.

Both the two-year and 10-year government bond continue to rally bringing their yields down to multi-month lows. As bond yields decrease as prices increase, a drop in bond yield translates into appreciation of the instrument. Unless the government renames Erdem Başçı, the current governor of the CBRT, as head of the bank, this latest rate cut was probably Başçı's last. While many names are rumored to be on the short list to replace Başçı, no decision seems to have been made at present.

Despite the fact the CBRT did not actually cut the benchmark interest rate, a cut of the overnight lending rate may be a signal that the benchmark rate is next to be cut. The next meeting of the Monetary Policy Committee should reveal the intentions of the bank and potentially its newest chairperson. The "foreign participation in Turkish equity markets" index, published by the Central Registry Agency, also hit multi-month highs with near 64 percent of Turkish equities traded on the Borsa Istanbul stock exchange owned by "foreigners." Should the U.S. economy cool down, as expected, a continued flow out of mature markets and into emerging markets will continue. The ECB appears to be ready for a prolonged state of negative interest rates and bond-buying, and this will further push investors out of Europe and into countries such as Turkey.

While crude oil has rallied in the last two months, up nearly 25 percent, its ascent appears to have stalled. Any future dip in oil prices will only continue to bring inflation lower in Turkey and may lead to a rate cut in the benchmark rate as well.

Turkey's "riskiness" also appears not to be effected by the CBRT's announcement as Turkish credit default swaps (CDSs) fell on Friday and Monday from their post-announcement highs. Turkey's economics and political riskiness as measured by CDSs is actually lower than eurozone member Portugal. While Portuguese CDSs currently trade at 2.72 percent, Turkey's CDSs currently trade at 2.70 percent making Turkey the less risky country. Factoring in the armed conflict raging on Turkey's borders and the fact that Turkey does not enjoy the implicit guarantee of the ECB as Portugal does, Turkey's CDS is actually very good.

The U.S. presidential election cycle continues on with only a few key races remaining before the nation's two largest parties decide who their nominees will be for the presidential run-off this November. While the odds are in favor of it being a Donald Trump versus Hillary Clinton race, a strong showing by Bernie Sanders, the winner of six of the last seven elections, may put this theory to the test. While Donald Trump continues to do well in his elections, a late rally by Ted Cruz or John Kasich may also complicate the nomination process. Markets fear uncertainty and a resolution of the candidates will only help to put the U.S. economy back on track.