Global risks and growth cycles
As political uncertainties and systemic risks blur the economic environment and weaken the forecasting prowess of many a financial analyst and institution, it is rather difficult even to guesstimate the future. On the one hand, Brexit does signal more than it actually looks like: it could be the trigger of a slow but painful decay of European institutions, even their demise. Now that the grandiose plan of the last century’s “federal Europe” has already faded away it is possible that if European integration cannot go farther than it has, it may not even stand as it is. France and Germany are the two pillars, historically and otherwise, and the coming to power of an anti-European Union party in either of them – France is the prime candidate obviously - might lead to further demise in the visibility of what Europe might look like in the future. On the other hand, although very different in terms of its historical roots compared to European extreme right-wing movements, the emergence of a business tycoon as head of state in the U.S. with a political discourse and style of a bona fide right-wing authoritarian populist reminiscent of notyet completely forgotten infamous examples, does not provide comfort either. On top of all this, the new Fed top stance points to a halt in the hiking process, and so are the key statistics in American economics. True, U.S. inflation may not remain tame, but it is also correct to assume that the recovery cycle has already matured, and this is what at least two figures from the Fed’s top brass have openly stated. The ECB stance, on the other hand, is difficult to pinpoint with reasonable accuracy. At the very least, we may believe the ECB cycle will be delayed, and tightening in the Euro zone isn’t near.
Other r sks
China’s economic dominance might does not go unchallenged either, and this for two reasons mainly. First, the idea of Greater China coming back with a vengeance, setting back the clock to 1820 when the first European power emerged on Chinese territory, and going back to square one after two centuries does not look realistic. Not only is Chinese growth set to slow down as a result of financial fragilities and because the giant economy has to revert back to a more consumptiondriven, domestic-demand based, long-term average growth rate, but also because the Chinese innovation capacity does not look on a par with its productive capacity and its political might in the Pacific. Second, here enters the Trump card, which could well amount to a radical shift in the American foreign policy-cumeconomic strategy mix towards further ‘containment’ of China’s influence, whatever that means in the Sino-American geostrategic context. Financial flows and trade patterns are expected to change both in terms of direction and intensity. Currency wars and protectionism could still well be on the agenda now. However, one should be warned: there is no going back to the infamous 1930s, and certainly not to 1914-1918, despite the fact that even the IMF chief Lagarde warned of the dangers of trade frictions. That would not do and it is impossible, either with Trump, Putin and Marine Le Pen or without them. Nonetheless, the fact is that a new phase in the global trade, growth and risk appetite cycles is approaching.
Turkey’s “visibility field” – or lack of it thereof - is also rather narrow and dim these days. This is, or should be, another concern for everyone, given its geography and its status vis-à-vis the EU and NATO. There are at least two deep and long-term causes that may explain the path to the “near – or quasi - stagnation” the economy has been struggling with over the last five years in order to avoid that pitfall. First, the growth model is stuck. The model depends on securing international funds in whichever form, and spending them either for consumption of for infrastructure investment. There was nothing inherent in this kind of “provide comfort for the international investor, cut off the excessive risk premiums, rely on real estate development alone and do not care about productivity and all that” model which could render it sustainable. Second, foreign policy did not help in the last few years either. Both are bound to change, and they have changed somewhat in the last couple of months, but the possibility of a sea-change in the warranted direction seems uncertain. However, there is now at least the chance of a yet another ‘muddling through’ possibility
for 2019. Since local elections are only four months away, ‘muddling through’ is the only thing one can hope for, at least until April. The radical percent-strategic economic policy change we expect to see afterwards will seal the fate of the years to come. True, the Fed might stop after two more hikes, and yes, it is possible that EMs come into favor anew, just as they did in the last few weeks, but relying on this kind of whimsical change can only add insult to injury, and what has happened before often times will happen again.
We tend to think that the currency market has been temporarily stabilized. In other words, we do not foresee another shock to the TRYUSD or TRY/EUR path in the next month or so. There may be some kind of disturbance ahead of the elections, but it will probably be nothing like the kind of depreciation we have already witnessed. On the other hand, the U.S. economy is now a shifting ground, and even if half of what Mr. Trump has promised is realized, interest rates will stagnate. Having said that, I don’t for a moment believe that the Fed is following the President, but in the end, even though for other reaons, the result will be the same. We factor in two FFR hikes this year, and a full stop thereafter.
On the other hand, the relocation of American capital to America requires incentives that should come hand in hand with rising public expenditures. Since financing expenditures through tax increases does not look a viable option, given Mr. Trump’s background as a businessman and his party’s ideological stance, the only way to finance them is through rendering fixed income and capital markets returns attractive. Now this has happened twice in U.S. economic history in the last 40 years or so. In the first, the interest rate differential channelled European and other funds to U.S. Treasuries between 1981 and 1985, an epi- sode that ended with the Plaza Accord. The USD/GBP rate was at par in 1985, and the dollar lost value against the DM only after the multilateral intervention in 1985. On September 22 that year, finance ministers gathered at the Plaza Hotel in NYC and called for an “orderly appreciation” of the major currencies against the dollar and the U.S. agreed to take full part in the co-ordinated exchange market intervention. The impact was instantaneous. The dollar fell by four percent in a single day. The average dollar depreciation between September 1985 and February 1986 was 3.5 percent and the USD/DM rate dropped from 3.47 to 2.25 in the same period. In the second case, the stock market “bubble” lasted for almost five years between 1996 and 2000, an episode that ended with the 2001 recession when the bubble finally burst. Ray C. Fair from Yale demonstrated more than a decade ago that the exceptionally high P/E ratio was a one-off, albeit a long-lived one. S&P 1996-2000 data shows how foreign transactions lifted up stock market multiples. Foreign investments accounted for almost all the difference that was observed in the historically very high P/E ratios at that time. Could these two episodes, or a combination of them, be repeated going forward? Not at that scale perhaps, but the tendency has already become visible in 2018, as expected.
This is despite the expectations of a halt in the hiking cycle. Because balance sheet contraction will have a similar effect, the USD may remain strong despite the rate hike stop.
Turning to more mundane issues, it is obvious that the government aim is to fuel domestic consumption demand once more through the credit channel by means of lower interest rates throughout. However, that may not work out this time around; and they have a second card up their sleeve. Since public finances are rather healthy in general terms, it is possible to rely a bit too excessively on budget expenditures for another year and keep GDP growth rate at around 2 percent next year. Hence, maybe there won’t be any ‘technical recession’, but after all, do we really need negative growth for there to be a recession? More likely is that it will grow at significantly less than 2 percent, given that private investments do not contribute to growth at all. Technically, a consecutive two-quarter contraction looks likely, and Q1 2019 does not look brilliant either. We would expect any rebalancing to come fully to the rescue only in Q2 next year. For the time being, we should be content with the narrowing trade and current account deficits, lower oil prices and so on. Q3 2019 might prove to be the beginning of an upturn though. At least there will be a positive base effect, and until that time many uncertainties will hopefully be resolved. Hence, two quarters of on average near-zero or negative growth plus another quarter of ‘muddling through’ (Q2 2019), after which we wil see what the automatic stabilizers can do. If there will be a seachange after the elections, of course it will be much better than ‘muddling through’.
As long as domestic demand isn’t fueled again beyond repair, and as long as the TRY doesn’t appreciate much due to a reversal in the risk premium – which is still not the case given the CDS- exports will come to the rescue of manufacturers. Inflation will automatically fall to around 15 percent by mid-summer 2019, and interest rates will gradually follow suit. This, along with a negligible current account deficit – negligible by Turkish standards - may suffice to bring in a quasi-automatic recovery. However, there is a price to be paid before that, I’m afraid.