Tense Start of the Week

March 22, 2021

• Turkish President Erdogan shocked the market by replacing the central bank governor, sending the lira on a tailspin

• The virus dramas continue to deepen with some E.U. countries moving towards extending lockdowns and threatening to block vaccine exports to the U.K.

• Market pricing for the first Fed hike continues to adjust towards earlier tightening

• The increase in global yields has been a global phenomenon, but it has been happening faster and earlier in EM than in developed markets.

• The PBoC kept its lending rates unchanged, as expected.

The big market-moving headline over the weekend came from Turkey as Erdogan shocked the market by replacing yet another central bank governor (see below). The lira plunged 15%, with USDTRY touching 8.4707 high though it has since retraced to around 8.0. U.S. Treasury yields are down 4 bps in the 10-year sector to 1.88%. APAC equities were mixed at the start of the week, with Japan and H.K. lower but China and Taiwan higher. European equities and U.S. futures are mostly lower but in narrow ranges. Risk appetite was further hurt by the EU upping the ante in its vaccine battle with the UK, stating that it is ready to withhold shots exported to Britain. In the commodities space, oil continued to fall, as did gold and Bitcoin.

The increase in global yields has been a global phenomenon, but it has been happening faster and earlier in EM than in developed markets. After many years of rate convergence, the spread between the Bloomberg/Barclays indices for EM (local yields) and G7 bottomed out at around 270 bps in the depth of the pandemic. With the start of new fiscal spending efforts and yields in developed markets bottoming, that process has started to reverse around Q2 of 2020. They have been mainly on a steady uptrend since, now at 310 bps, and we imagine it will continue widening. Though central banks across EM are becoming more hawkish (Brazil, Russia, and Turkey, until yesterday), we still think a rising risk premium for EM is inevitable. Many countries will face challenges navigating the next few years of reflation, rising fiscal burdens, and growing competition for debt rollover. We do not see any meaningful spillovers from the latest Turkey crisis into other EM assets.



Market pricing for the first Fed hike continues to adjust. Higher odds are creeping further into Q3 2022, and a hike is fully priced in by Q1 2023. This is at odds with the Fed’s Dot Plots showing steady rates through 2023. If this timetable continues to accelerate, the Fed may have to push back more forcefully against any notions of tightening coming sooner rather than later. At the margin, enhanced Fed tightening expectations should help boost the dollar, as other central banks are likely to follow the Fed much later. We saw a similar dynamic play out during the financial crisis. But the opposite is likely to happen if the Fed is perceived to be behind the curve or tries to repress longer-dated yields while inflation risks are picking up.

The Fed said it would let relief from the so-called supplementary leverage ratio (SLR) expire on March 31. Chair Powell said during the FOMC press conference last week that a statement would be made soon, and we got it on Friday. This can’t have been too much of a surprise, as Fed data show primary dealers sold more than $80 bln of U.S. Treasuries over the past couple of weeks in advance of the announcement. This emergency relief excluded USTs and deposits held at the Fed from capital requirements granted at the beginning of the pandemic. With the economy on the mend, it was no longer needed. Still, the Fed said it would soon propose longer-term changes to the rule to address its treatment of what is considered “ultra-safe” assets.




Turkish president Erdogan replaced the central bank governor just two days after delivering a higher-then-expected rate hike – so much for its hard-earned credibility. He is the third central bank governor in two years. And the replacement, Sahap Kavcioglu (former AKP parliament member and professor at Marmara University), is decidedly more dovish. Recent public comments by the new governor are in line with President Erdogan's unconventional views on interest rates. We don’t have a strong view yet on whether he will just stop the tightening cycle (+1075 bps since mid-2020) or go as far as reversing the latest hikes, but whatever happens, it’s hard to see a favorable scenario for the lira and local assets. We also imagine this move will accelerate the ongoing process of dollarization of savings and the economy. Price action has been as volatile, with TRY netting out a depreciation of around 9% since the news broke, while CDS are blowing out by over 150 bps to 470 bps, local rates are spiking higher, and the BIST 100 index is down over 9%.

The virus dramas continue to deepen with some EU countries moving towards extending lockdowns and threatening to block vaccine exports to the UK. Needless to say, if the EU goes ahead in withholding vaccines to the UK, it could escalate into a serious diplomatic row that might have long-reaching consequences. In terms of lockdown, German Chancellor Markel is moving towards extending lockdowns for another four weeks. France has been under stricter restrictions since March 20, with an estimated 40% of the economy affected.

The ECB will release its data on weekly bond holdings soon, though the breakdown of the purchases will only come out on Tuesday. This event takes special importance after the ECB stated it would buy bonds “at a significantly higher pace” via its Pandemic Emergency Purchase Program (PEPP). Purchases have averaged around $12.5 bln per week this year. Compared to most other major central banks, we still think that the ECB is far behind in their concern about rising yields. We don’t expect any huge change in purchases, at least until we see evidence of transmission of rates to the real economy or spreads to periphery countries and corporate widening.



The PBoC kept its lending rates unchanged, as expected. The 5-year loan prime rates remained at 4.65% (reference for mortgages) and the 1-year at 3.85%. Indeed, PBoC governor Yi Gang noted that policy “is in a normal range,” we should only expect fine-tuning for now. There was a minor reshuffling of roles within the PBoC’s MPC, but unlikely to be of any immediate consequence for rates or markets.

Korea’s external trade numbers softened somewhat in the first 20-days of March, but this was in part due to working-day calendar adjustment. Exports increased at 12.5% y/y and imports at 16.3% y/y, which are still solid figures even considering the adjustment. The good news is that foreign demand seems to be broadening beyond the tech goods, such as semiconductors, and into other areas such as vehicles and petroleum products. Separately, tensions on the Korean peninsula may rise after North Korea criticized the Biden administration and ruled out talks with the U.S. for now. Comments came as U.S. Secretary of State Blinken and Secretary of Defense Austin visited South Korea last week.

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