Erdogan’s “Whatever It Takes” Moment: Comeback Story Of A Lifetime Or A Giant Headfake

By Bas van Geffen of Rabobank

“Race isn’t over until the finish line.
It’s a comeback story of a lifetime” – Kings of Leon

Overnight, USD/TRY has made what has to be one of the sharper turnarounds in recent history. For the currency itself, it certainly is: Bloomberg reported that this is the strongest daily rally for the lira since at least 1983. After the lira slid past the 18 mark yesterday, the currency recovered all the way to around USD/TRY 11, before its current levels of about USD/TRY 13.

This sudden reversal of fortunes came as President Erdogan announced a series of measures to support the lira. Most importantly, the president introduced a scheme that will protect savings from FX fluctuations. Through the program, the government will compensate lira deposit holders if the currency’s value depreciates by more than the interest rate offered by banks on these deposits. The objective of the scheme is to stop retail demand for hard currencies like USD and EUR.

If anything, I would describe the move as a verbal FX intervention. In fact, it could even mean that the central bank does not have to spend one more cent in FX reserves on actual interventions, as long as Erdogan’s pledge manages to support the lira. The closest comparison I can think of is former ECB President Draghi’s “whatever it takes” pledge to keep the Eurozone from falling apart due to the extreme widening of sovereign spread during the debt crisis. Indeed, even though Draghi’s words birthed the OMT facility, the ECB has never had to invoke it.

Of course, there is a crucial difference between the European Central Bank –a (mostly) external party– pledging support to some of its member states and the Turkish president pledging to support its own currency (or rather, depositors). If Erdogan’s pledge is challenged, and the lira loses value, someone will have to pick up the tab. And the recent FX interventions by the CBRT have only worsened Turkey’s already low foreign reserves, potentially eroding the credibility that the president can indeed compensate all losses if the lira were to face new headwinds. It also means that – in classic bank-run mechanics – there is a first mover advantage in case there is any doubt amongst TRY deposit holders. Plus, the government’s finances are now even more linked to the currency’s performance, which could exacerbate shocks if credibility risks materialize.

So, despite the miraculous recovery in after-hours trading, the verdict is still out whether this stops the TRY’s bleeding. Indeed, the country’s CDS spreads remain at elevated levels, and President Erdogan does not seem to have strayed from his fundamental view that interest rates should be lower – the root of the lira’s problems.

In a far less exciting turnaround, equity markets seemed to have changed direction after a few weak days on the back of Covid concerns and the news that Senator Manchin would not back President Biden’s Build Back Better bill. Asian indices are currently in the green, and futures are pointing to better opens for both Europe and the US as it appears that the bill may not be dead and buried yet. Manchin has outlined a number of changes he would like to see to the bill before supporting it, and this paves the way for a new version to make it through Congress – albeit not until the new year.

Staying on the topic of turnarounds, yesterday Reuters reported that “quite a few” ECB policymakers wanted a greater acknowledgement of upside inflation risks, according to sources. It is not surprising that especially the hawks in the Council will have pushed this view, with the ECB being one of the few remaining central banks sticking to its assessment that inflation is still mainly driven by transitory factors. However, interestingly, yesterday these traditional hawks also received some backing from Vice President De Guindos, who acknowledged that inflation is “not as temporary as we expected”. Reuters’ sources suggested that the Council’s debate had ended in an agreement that there are “small upside risks” to the inflation forecast, even though this was not reflected in the press conference afterwards.

This more hawkish tone on inflation is somewhat conflicting with earlier communication, and could even suggest a very gradual change of view. After all, if quite a few Council members wanted to acknowledge such upside risks, it does not rhyme with the ECB’s fundamental views to date.

Firstly, in October, an extensive assessment of Eurozone inflation confirmed their view that key drivers are of temporary nature, and the ECB maintained that there is still little evidence of second round effects. Secondly, Lagarde noted during her latest press conference that the ECB’s new inflation projections actually accounted for quite high rates of wage growth. This suggested that the ECB’s inflation projections are on the high end of the range, and that there needs to be substantially greater wage pressures before the ECB’s new projections would need to be revised up again. In other words, accounting for relatively high wage growth at times when they see limited second round effects should actually imply that risks to the forecasts are skewed to the downside, or at best balanced. Now, the abovementioned consensus support for ‘small upside risks’ to inflation may have of course been a concession to the hawks. We will have to wait for the accounts to see how widespread the Council’s concerns really were, and whether the ECB is also slowly turning towards leaning against inflation.

Meanwhile, we now also know that Joachim Nagel will succeed Bundesbank President Weidmann when he quits at the end of the year. And it appears that Nagel will continue to defend the German approach to monetary policy, although he might be a tad more moderate than his predecessor. Having held a post at the Bundesbank’s board between 2010 and 2017, Nagel has shared some reservations about the ECB’s (then) extraordinary policies, including APP and the abovementioned OMT. Of course, it is unknown how his views have changed since then.