Daily Note – Fog on the Bosphorus

Fog Summary                                                                                                                                 

United States: Weather continues to play havoc with economic data points

Turkey: Rates on hold but the CBRT is ready to act on renewed market pressures

United Kingdom: CPI moves below the BoE target rate for the first time since 2009

Eurozone: ZEW Investor expectations take a dive in February


Good morning from Istanbul

Last night I looked out over the Bospherous from the lovely apartment which I am renting here, thanks to the brilliant airbnb. Across the river, the lights of Sultanamet twinkled. To the left at the tip of the Golden Horn was Topaki Palace, the royal seat of the Ottoman Sultan. Straight ahead, lit up marvellously Haihi Sophia and to its right the enormous Blue Mosque. These landmarks seemed so close you could touch them.

This morning, as I write, they are gone. Istanbul, Europe’s largest city, home to close to 14 million souls is covered in think, dense smog. You can see nothing.  From memory, as I gaze out towards where these landmark used to be, I have an idea where they should be, but everything is shrouded in mist.

In a way this lack of visibility is emblematic of investing in Turkey and many other emerging markets right now.

The key thing when the outlook is so foggy, is to get the big things right, don’t get too bogged down in the detail and the spin and counterspin because when a country is in crisis, everyone is telling their own story, talking their own book and trying to pull the wool over someone’s eyes, somewhere about something!

Last year, the Turkish economic miracle came to an abrupt end with political violence in the streets of Istanbul, Izmir and Ankara. The currency went into free fall as did the stock market. Prime Minister Recip Erdogan, whose AK Party won three general elections, restructured the economy and attracted more FDI in a decade than in the entire 90 year history of the Turkish Republic came unstuck.

He has lost his aura of invincibility. When successful quasi-autocratic lose the aura, its hard to get it back without a big scrap. In Turkey the political power base seems to be shifting to a parallel power know as Gulenists – which sound like a cross between Islamic version of Opus Dei and the black Nation of Islam movement. There is an excellent piece on this in today’s Financial Times here.

Right now, high yielding Turkish debt is being flogged by investment banks and local brokers who suggest the crisis will blow over.

But how could any investor in his right mind invest in Turkish lira bonds knowing that Ankara has only $40 billion in central bank reserves (two months import cover) but has to re-finance $210 billion in 2014 alone?

Turkey has a $70 billion current account deficit, which is financed by offshore hot money and that has been fleeing back to the safety of the USA in billions everyday..

From where I am sitting, it seems that Turkey’s Achilles heel is its corporate sector’s colossal dollar debt. Turkey looks like a big Ireland in 2006 or you could take Thailand 1997 as your model or what not Greece in 2010?

As we said before and speaking as a former central banker, the idea of raising local interest rates to protect the currency when there is huge internal debts is a doomed policy. Over time as the lira tanks, the corporate sectors debts will become overwhelming and the banks will have to deal with mounting bad debts.

My sense is that Turkey will offer an amazing opportunity soon, but just not yet. I will keep you posted about what else I find out in this fascinating city, once the fog lifts a bit.

Speaking of fog and weather, the cold continues to disrupt the functioning of the US economy. But in comparison to Turkey, the US is frankly boring.

United States: Weather continues to play havoc with economic data points

Table 1 19:2

Americans are neither building nor buying houses in this weather. The NAHB housing market index fell to 46 in February (vs. consensus 56), a sharp decline from 56 in January. By component, present single-family sales (-11pt to 51), future single-family sales (-6pt to 54) and traffic of prospective buyers (-9pt to 31) declined.

Geographically, the index posted large declines in all regions, with the West seeing the sharpest drop. The NAHB attributed the decline to severe weather conditions and concerns about the availability and cost of supplies and skilled workers.

The Empire manufacturing index fell to +4.5 in February (vs consensus +8.5) from +12.5 in January.

The divergence in sentiment between US equity and fixed income investors continued to widen yesterday. Fixed income investors grinded yields lower (our 5Yr note yield fell to 1.47%) while equity investors pushed the S&P 500 to a 1843.

We continue to see this divergence as our key focus. An equity market in tandem with higher bond yields and stronger USD makes sense to us from a growth and earnings perspective, yet the opposite is happening at the moment.

Japan: Japanese finance ministry official says the theory that weak yen boosts exports is no longer true

Following on from our work yesterday on the Yen weakness doing little to improve the net exports of the Japanese’s economy,  we noted with keen interest comments out of the Finance ministry.

United Kingdom: CPI moves below the BoE target rate for the first time since 2009

Table 2 19:2

A few months back, I suggested that Mark Carney was “lucky”, well his luck continues. CPI inflation in the UK declined from +2.03% yoy to +1.88%yoy. This is the first time that CPI inflation has been below the MPC’s 2% target since November 2009.

While there is some debate in the UK around the primary drivers of the drop in inflation, we are of the firm belief that it is down in no small part to the stronger currency. As you can see in the chart below CPI has been dropping in lock step with the strengthening of the pound.

Figure 1: UK CPI vs GBP

Chart 1 19 Feb

The strengthening pound has increased the purchasing power of both the consumer and the UK corporates. In contrast, to the Eurozone when the deflationary forces are moving in lockstep with poor underlying growth the UK grew at circa 3% last year and is expected to again this year.

Eurozone: ZEW Investor expectations take a dive in February 

 Table 2 19:2

While the current situation number came in better than expected the expectation number (leading indicator) took a dive. The first time we have seen weakness in a number of months. Again according to the ZEW it all came back to weaker US data.

  • Cautious expectations likely to be caused by some new uncertainties
  • Weak unemployment figures dampened leading indicators and have caused concern in US that current economic upswing could lose momentum
  • This month’s decline must not be overstated, the majority of respondents remain optimistic

Looking at the chart below it would suggest that there is some downside to the more closely followed IFO number next week.

Figure 2: Some downside risk to German IFO next week

Chart 2 19 FEB

Eurozone: ECB forecasts may show inflation below 2% in 2016 says Nowotny

ECB board member Nowotny certainly has no fear of the mic, as he made some further comments in London yesterday.

  • No imminent deflationary pressure from periphery
  • If ECB cuts key rate then deposit rate should be cut
  • Negative deposit rate should be treated with great care
  • Chance that low inflation and strong Euro will “self correct” without need for action
  • Cites German wage increases as one factor to consider

It does seem, on the margins, that the ECB is positioning itself for something further, we expect March or at the latest April. The Euro has rallied nearly 2% since the last ECB meeting (erasing some of our good profit) but more importantly for the ECB the nominal effective FX rate or trade weighted is heading back to the highs last seen prior to the base rate cut last November.

Figure 3: Euro Nominal Effective FX rate

Chart 3 19 FEB

This will add flames to the “deflationary “fire as the struggling peripheral economies in the absences of a competitive gain from the FX will have to further “devalue” internally.

Portfolio: Good gains in the China ETF offset losses elsewhere

Table 4 19:2

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Global Macro 360-Daily Note-Fog on the Bosphorus




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