Inside out, upside down
It isn’t just the Fed rates, the balance sheet contraction or money repatriating to safe havens. Trade, manufacturing, trade wars, the Ukraine war and energy shortages also matter. They are all moving in a negative direction compared to what supranational institutions expected a couple of months ago.
• Since fixed-income security returns turned negative, floating and inflation-indexed bonds have come to the forefront. Gold might also keep its appeal. After all, gold and FX-denominated domestic debt stock accounts for 30% of the lot.
• Inflation is the greatest concern. Therefore, a massive CPI-linkers issuance could render TRY more attractive indeed. So far, the exchange-rate protected deposit scheme has only had a limited impact.
• There is a huge difference between exchange-rate protection and inflation-indexed bonds. In both schemes, the Treasury will eventually pay the bill. In the first one, however, holders of FX-protected TL deposits actually want the exchange rate to go up.
• This is why this device is a contradiction in terms. If it pays nothing substantial over the 17% flat TL deposit rate, people will shy away from it. Inflation-indexed TL bonds aren’t an inherently contradictory instrument. They aren’t new. The whole world issues inflationindexed bonds from time to time.
• The holders of this type of bond will not be unhappy if inflation falls because they know they will be compensated at a rate above inflation, whatever that inflation may be. Good point, but this isn’t the end of the story.
• This isn’t the end of the story because nobody knows the genuine inflation rate today. Is it 70%? Is it higher? If it is higher, how high is it? If people do not trust the measurement, why would that instrument appeal to millions of citizens?
• There is also the problem of duration. For CPI-linkers to have a positive impact on exchange rate stability, they should be long-term. Given the cloud of uncertainty surrounding economic policy, banks and high net-worth individuals will aim at shortening their duration.
• This is probably the only similarity with the rate hike course because if the policy rate is raised the initial impact will be adverse. People would think other rate hikes are in the making and they would price securities accordingly. CPI-linkers might indeed work but only at a high cost to the Treasury and only if they crowd out most of the other debt securities immediately.