Believing fairy tales

The U.S. Federal Reserve is still asking the market to believe in the Goldilocks scenario: an economy that’s sufficiently hot that we’ll see rampant growth this year, but not so hot that any “bulge” in inflation, to use Chairman Jerome Powell’s words, becomes problematic. And, as if that’s not enough for the equity bulls, there’s still the forecast by the Fed that it can keep policy rates at current levels through to at least 2024. It seems too good to be true – and probably is – because the Fed is also more uncertain than it has ever been. So, a key issue is whether the rise in actual inflation in coming months, as annual prices “bulge” due to low base effects from last year, work their way into expectations for the future. Analysts may think that with soaring economic growth and near zero policy rates, bond markets will not share the Fed’s faith in fairy tales. As a result, yields should keep rising, with the 10-year Treasury likely to be up around 2% by mid-year.


The Central Bank of the Republic of Turkey positively surprised the market with its rate-setting decision, delivering a 200bp hike to the benchmark one-week repo rate, thus bringing it to 19% from 17%. This exceeded our expectation and the market consensus of a 100bp hike. We continue to like long Turkish lira positions, even in the current reflationary context where Turkey’s vulnerabilities are heavily exposed. CBRT action has benefited our latest incarnation of short EUR-TRY, which is now up +2.5% inclusive of the positive carry. rates curves have flattened in response to the CBRT’s decision, with front-end FX swaps and cross-currency rates repricing higher, while long-dated rates are plunging. 10y Turkish cross-currency swaps at 13.84% are 32bp lower on the day, while 10y TURKGB yields at 13.56% are 26bp lower. Further curve flattening is likely, particularly as the long end of curves gradually decline in response to lower inflation expectations. The CBRT will likely maintain policy rates at the current level until Q3 2021.

Phoenix Kallen, strategist, Societe Generale, March 18


Citing deterioration in the inflation outlook, the CBRT delivered a 200bp hike to 19%, higher than the consensus and our forecast of a 100bp hike. While there are very early signs of higher lending growth, we were surprised to see this comment in the CBRT’s statement. Despite a major tightening in monetary policy conditions since Q4 2020, and a major rise in deposit yields, the de-dollarization trend has been far from ideal. FX deposits, adjusted to EUR/USD parity and gold price effect, have remained roughly stable and residents have not converted the $40bn bought in 2020 into TRY despite lucrative TRY rates. An additional 200bp rise in TRY deposit rates might help this trend, but expecting a quick reversal of the last 10 years’ dollarization is unrealistic, in our view. By defining today’s move as strong front-loaded tightening, the CBRT has signaled the end of its tightening cycle. We expect to see CPI peak at 16.8% y/y in April and to end the year at 11.2% y/y.

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