Turkey: End of the Benign Cycle in Inflation?

The results of Turkish central bank’s survey of expectations released which showed that participants were expecting to see monthly reading of 0.65% in May inflation. Having said that, the year-end CPI growth is now projected at 7.80%, 11 basis points lower when compared to the linked month. 12-month and 24-month expectations almost remained unchanged at 7.81% and 7.14%, respectively.

Turkey - Inflation Expectations - May 2016Considering the fact that a monthly inflation of 0.55% was reported in May 2015, the survey signaled the end of the benign cycle in inflation. Despite a core inflation remaining stubbornly high, the surprising decline in headline inflation painted a rosy picture for the monetary policy outlook. However, the decline was primarily driven by the base effect which now seems be not supportive anymore. Note that inflation in Turkey hit a 3-year low in April at 6.57%. Since we expect monthly CPI growth to be at 0.7% which is 5 basis points higher than consensus, the annual inflation, in our view, should hit 6.75% and finish the easing process.

Meanwhile Turkey 10-years bond is currently trading around 10%, almost 100 basis points higher since the beginning of May. The core inflation around 9.5% keeping real rates extremely low results in a need for a higher risk premium for Turkish bonds. With oil prices set to be higher for the rest of the year and the strengthening US dollar would continue to support a switch between Turkish and Russia ’43 Eurobonds since Turkey’s current account deficit will weigh on the its assets in this scenario.

10y US Treasury As A Global Markets Driver

At the center of all financial markets, we have the market for US Treasury. US fixed income market play a crucial role in the global economy. Treasurys are denominated in US dollars, the main currency used by central banks and major financial institutions around the world. Because the US government owes so much and because investors expect the US government to honour its debts always, the Treasury market is considered the cornerstone of the global financial system.

If we stay focused on Turkish bonds markets, it is hard to regret that it moves in a similar way as US market does after seeing the chart below.

US and Turkey Yields

Well, ahead of FOMC meeting, the rumours are main dynamics and shaping the opinion of all global markets. What we saw previously in US bond market is that the Fed is frightened to death by a sharp rise in yields. It is rational to expect Turkish bond market to maintain the trust of marketplace for a few weeks more.