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EM rout: Bye-bye TRY, BCB on hold
End of CBT independace … bye bye TRY
Turkish Lira was swinging in a precarious position after losing over 21% against the USD since the start of the year. Geopolitical and domestic uncertainties, real interest rates are negative and heavy USD current account have markets yelling for deeper devaluation. Yet there was a thin hope that the CBT would regains control of the destabilizing TRY sell-off by raising interest rates. However that was killed as President Erdogan’s in a Bloomberg interview clearly indicated that new executive powers give him the right to drive monetary policy. At that moment effectively killing the CBT perceived independence and any hope that TRY sell would stop over the mid and long term.
I went on to confirm hat he wanted lower interest rates. This declarations that the CBT should listen to the guidance of the executive head of state significantly lowers the probably of an “emergence” interest rate hike. Move in interbank rate indicate that 175bp of rate hike are price in yet in the broader capital flight environment the exact implications are less certain. Heading into the June 24th elections is not a given that interest rates would be immediately chopped by 300 -400bp however this result cant not be ruled out. In the current environment our base scenario for TRY is further weakness and despite short term development that long game for Turkey and CBT remains severely negative.
BCB forced to hold rate amid EM rout
The Brazilian central bank held interest rate steady yesterday at odds with market expectations. Indeed, market participants expected that the BCB would keep going with its easing cycle by cutting the Selic rate by 25bps to 6.25%. Instead, the bank maintained the Selic at 6.50%. This surprise decision signalled that the institution has realised that the global outlook has become more uncertain, especially for emerging market.
Indeed, the Brazilian real had a rough month so far as it lost around 10% against the greenback, with USD/BRL hitting 3.6944 (the highest level since April 4th 2016) yesterday. Despite sound levels of inflation - 2.76%y/y in April - the currency weakness is casting a shadow on the price outlook as Brazil could start to import massively inflation (through its imports). Therefore, we think that the central will rather wait for the dust to settle before resuming its easing cycle. Regarding the Brazilian real, the current global environment – the Fed’s tightening cycle together with the geopolitical situation – does not allow for excess optimism.
Central Bank of Mexico to maintain rate unchanged
At today’s monetary policy meeting, Mexico’s central bank is expected to hold its overnight rate at 7.50%, maintaining a hawkish stance though. Currently given at 9-year high, Mexican key rate steep rise in the last two years continued amid increasing concerns with regard to swelling inflation and North American Free Trade Agreement (NAFTA) reconsiderations. Indeed, starting from 2016, consumer prices rose from 2.61% to 4.55% on year-to-year basis, putting Bank of Mexico’s 3% inflation target far off the mark.
Looking at the broader picture however, inflation eased quite significantly, decreasing from 6.80% (y/y) in December 2017 (16 years high) to 4.55% in April, a rather encouraging trend for the Mexican monetary authority who’s been struggling for a long time to stabilize this situation.
Accordingly, despite an inflation rate above the target, we would rather favor an unchanged interest rates scenario due to current interest rate levels and higher-than-expected slowdown in inflation rate since the beginning of the year, though continued weakness on the peso could be a hurdle if the greenback would be gaining ground.
As NAFTA talks seem to converge toward an encouraging outcome, we would expect the Mexican peso to regain strength in the near term. Strongly depreciating since mid-April 2018 (+8.25%) and almost flat since the beginning of the year (-0.69%), USD/MXN is currently weakening as May monetary policy meeting approaches. We suspect however tonight’s decision to have a rather subdued impact on the FX market in the short-term. Currently trading at 19.52, the pair is expected to decline further, heading along the 19.50 range in the short-term.