The International Monetary Fund has lifted its outlook for US economic growth to 7% for this year, and believes the Federal Reserve will raise interest rates by the end of 2022, as recovery takes root.
The IMF had previously anticipated an annual growth rate of 4.6% for this year. Should the US economy indeed by 7% in 2021 – as both the Fed and now the IMF expect – this would be the fastest expansion since 1984.
Kristalina Georgieva, the IMF managing director, said the improved outlook was based on the American Jobs and Families plans being implemented in line with the outlines presented by the Biden administration, as they appear likely to improve living and income standards in the long term.
“We believe that these two packages will add to near-term demand, raising GDP by a cumulative 5¼ percent over 2022-24. And-perhaps more importantly-our assessment is that GDP will be 1 percent higher even after 10 years, thanks to the significant, positive effects on labor force participation and productivity introduced by these two plans.” she said in a report released on Thursday.
Biden’s infrastructure plan was also referenced in the IMF’s assessment. The bipartisan program allocates $1.2 trillion over the next five years to improving things such as roads, broadband access and education.
The IMF also said it expected US interest rates to rise more quickly than the Fed currently anticipates.
“Presuming staff’s baseline outlook and fiscal policy assumptions are realized, policy rates would likely need to start rising in late-2022 or early-2023,” the IMF said.
At its mid-June meeting, the Fed said it expected to raise interest rates by 2023. Several individual policymakers have however since said they expect monetary policy to tighten sooner than this.
The Fed’s more hawkish outlook initially fueled some concern among investors, particularly relating to the implications for the central bank’s highly accommodative monetary policy stance. Stocks wavered for a few weeks, but have since recovered and hit successive record highs in the last week. Government bond yields have fallen to around six-month lows, highlighting that investors trust the Fed’s ability to target inflation without derailing the economy.
Both the IMF and the Fed expect inflation to be transitory and short-term, rather than weigh on markets for a prolonged period of time.
The Bank of England said it now expects UK inflation to surge above 3%, but nonetheless maintained its bond-buying target at $1.25 trillion, saying it still believed sharp price rises will be temporary.
Departing chief economist Andy Haldane was the only one of nine monetary policy committee (MPC) members to vote against the plans. Raising concerns that strong inflation may stick around, he voted to cut the bond-buying package by 50 billion pounds ($70 billion).
The Bank also decided to keep its main interest rate at the record-low level of 0.1%, in a unanimous vote, on top of 8-1 decision to keep the bond-buying package steady at 895 billion pounds ($1.25 trillion).
The pound fell after the announcement, and was around 0.25% lower against the dollar at $1.393.
UK inflation jumped 2.1% in May year-on-year, the biggest rise since July 2019 and above the Bank of England 2% target. It was a bigger rise than the central bank had expected.
The Bank said on Thursday that it now expects inflation to jump above 3% for a temporary period, “owing primarily to developments in energy and other commodity prices.” In May, it had only expected inflation to rise temporarily above 2%.
Yet the Bank’s MPC said it expects inflation to fall back again as commodities price rises fade. However, it said there are “risks around this central path, and it is possible that near-term upward pressure on prices could prove somewhat larger than expected.”
Central banks around the world are dealing with stronger inflation than has been seen for decades, as economies rebound sharply from the COVID-19 slump. Too much inflation is seen as disruptive for economies, and central banks try to keep it at around 2%.
In the US, where year-on-year inflation hit 5% in May, the Federal Reserve has signalled a slight shift in its expectations for monetary policy. Officials now predict the central bank will raise rates in 2023, according to “dot plot” estimates released last week.
Paul Dales, chief UK economist at consultancy Capital Economics, said: “Other than the MPC noting the growing upside risks to inflation at today’s policy meeting, there were no real signs that it is thinking about tightening policy sooner, à la the Fed.
“We think policy will be tightened much later than the mid-2022 date the markets have assumed.”
Maximum employment. Full employment. They may seem to be similar phrases, but they are dramatically different, in ways that could shape the US economy long after the pandemic ends.
After decades of adhering to an agreed-upon employment threshold called full employment, the Federal Reserve is trying a new playbook. In August, the central bank replaced this goal with “maximum employment” as part of a new policy framework.
Whereas the previous target sought to minimize deviations when employment was too high or low, the Fed now aims to “eliminate shortfalls of employment from its maximum level,” Governor Lael Brainard said in February.
Put another way, the central bank will push for a labor market that doesn’t just feature low unemployment, but also inclusivity and healthy wage growth. The new mandate sounds encouraging. But to achieve it, the Fed is entering uncharted territory.
How much unemployment can you have with low inflation?
The previous threshold for low employment rested on a concept known as the non-accelerating inflation rate of unemployment (NAIRU), which represents a level of unemployment at which inflation doesn’t spiral out of control. Though the true rate is unknown, the Congressional Budget Office estimated it stood at roughly 4.5% in 2020.
NAIRU served as a loose guide for the Fed as the US recovered from the Great Recession, but it didn’t quite work. The labor market’s recovery from the financial crisis was, and remains, the longest of any recovery since World War II.
Since the start of the coronavirus recession, Fed officials made it clear they weren’t going to use the same strategy. The Fed’s new framework seeks inflation that averages 2% over time. That opens the door to periods of stronger inflation.
Prematurely retracting monetary support can leave underserved communities hurting and set the US back for years, Fed Chair Jerome Powell said following the FOMC’s March meeting. By allowing for a brief period of elevated inflation, the central bank believes it can power a faster and more equitable labor market recovery.
“There was a time when there was a tight connection between unemployment and inflation. That time is long gone,” Powell said. “We had low unemployment in 2018 and 2019 and the beginning of ’20 without having troubling inflation at all.”
The maximum-employment experiment is uncharted territory
Despite Powell’s repeated messaging that stronger inflation will prove largely “transitory,” some economists slammed him for risking a dangerous inflationary spiral. Letting inflation run above 2%, they say, can spark a cycle of soaring prices that would cripple the still-recovering economy.
Keeping rates near zero into 2023 “seems to me at the edge of absurd,” Larry Summers, a former Treasury Secretary who has criticized the fiscal and monetary response to the pandemic, said at a May event hosted by CoinDesk.
“We used to have a Fed that reassured people that it would prevent inflation,” Summers said. “Now we have a Fed that reassures people that it won’t worry about inflation until it’s staggeringly self-evident.”
Higher inflation also tends to give way to higher wages, but rising pay might not benefit the economy as some hope. Fed analysis of how stimulus checks were spent suggests most additional income would mostly go toward paying debts and boosting savings, with only a fraction going toward spending.
Even the target for maximum employment isn’t entirely clear, as an unusually large number of Americans likely stopped working for good during the pandemic. A “significant” number of retirees skews estimates of the labor force’s size, Powell said in a Wednesday press conference. This effect “should wear off in a few years” as retirees are replaced with new workers, he added. Maximum participation will likely cloudy until then, whenever that is.
The unusually large jump in retirements through the pandemic could still give way to a stronger labor market, as was seen in the years before the health crisis, Randal Quarles, vice chairman for supervision, said in late May. Still, with uncertainties abound, the Fed may need to issue “additional public communications” about its progress targets and broader goal of maximum employment, he added.
That means maximum employment, while a worthy goal in many ways, carries more than inflation risks. It could be a cloudy and uncertain destination even for top policymakers.
Monetary and fiscal policies are leading to “significant inflationary danger,” according to Capital Economics chairman Roger Bootle.
In an interview with Bloomberg on Wednesday, Bootle repeated his concerns about inflation and criticized other economists and market commentators for their view that monetary and fiscal policies aren’t important when it comes to rising costs.
“Money supply doesn’t matter. The stance of policy doesn’t matter. You’ve got all these cost reductions, and you’ve got competition. I find all this terribly funny because there’s been globalization in Venezuela, Zimbabwe, Turkey, and all the other countries that have had quite rapid inflation,” Bootle said.
“When it comes to it, it’s the stance of monetary policy, the buildup of these big-money balances in the hands of households. The stance of fiscal policy. The very low-interest rates. I think this is what really makes this a particularly dangerous thing,” he added.
Bootle went on to say that current inflationary pressures are not on the scale of what was seen in the 1970s, but demographic changes and increased costs due to US-China tensions and climate policies will add to inflationary pressures moving forward.
There has been a heated debate among economists, banks, and analysts about inflation recently. Some argue, as the Federal Reserve does, that inflation is only “transitory” and will settle down once supply chain issues resolve themselves.
Others, like Bootle, argue that a rapid increase in the money supply along with dovish Fed policy could lead to sustained rising costs.
Despite the pandemic coming to an end, the Federal Reserve has pledged to maintain accommodative policies, including low-interest rates and aggressive asset purchases, until “substantial further progress” has been made toward employment goals.
Comments from Cleveland Federal Reserve President Loretta Mester in a CNBC interview on Friday showed the Fed appears to be doubling down on its view that substantial further progress needs to be made before they change policy.
“I view it as a solid employment report…But I would like to see further progress,” Mester said.
Roger Bootle’s new comments come on the back of Deutsche Bank’s recent warning of a global “time bomb” due to rising inflation if the Fed doesn’t act.
“The consequence of delay will be greater disruption of economic and financial activity than would otherwise be the case when the Fed does finally act,” Deutsche’s chief economist, David Folkerts-Landau, and others wrote in a note to clients.
“In turn, this could create a significant recession and set off a chain of financial distress around the world, particularly in emerging markets,” the team added.
An unusual imbalance between supply and demand in the labor market is holding back the hiring rebound, but the trend shouldn’t last long, Federal Reserve Governor Lael Brainard said Tuesday.
On one hand, job openings soared to record highs in March as the country reopened and businesses looked to rehire. Yet a hugely disappointing April jobs report suggested that, while demand for labor was strong, not enough Americans were looking for work. The phenomenon has since been referred to as a labor shortage, joining the various other supply bottlenecks hindering the economic recovery.
But, like those other bottlenecks, the labor shortage will reverse as the economy heals further, Brainard said while speaking at The Economic Club of New York. The Fed has repeatedly said it expects supply chain issues to be solved as the country returns to a new sense of normal and production capacity bounces back.
Brainard made a similar projection regarding the labor shortage. For one, only about half of Americans are fully vaccinated against COVID-19, meaning millions probably still fear catching the virus. Childcare expenses are also likely weighing on the return to work as parents elect to stay home. And the continued payment of expanded unemployment insurance gives unemployed Americans more time to stay out of the workforce.
It’s difficult to “disentangle” any one of the factors from another, but all three should fade in the coming months, Brainard said. Continued vaccination and the start of the new school year will counter virus fears and childcare needs, respectively. Separately, the federal boost to UI payments is set to expire by September and even earlier in at least 24 Republican-led states.
“For all these reasons, the supply-demand mismatches in the labor market are likely to be temporary, and I expect to see further progress on employment in coming months,” the Fed governor said.
Accelerated hiring would be a welcome sign as the recovery charges on. Employment “remains far from [the Fed’s] goal,” with jobs still down by more than 8 million compared to the pre-pandemic norm, Brainard said. That sum grows to 10 million when considering the job creation that would’ve taken place had the pandemic not slammed the economy.
The progress still to be made backs up the Fed’s ultra-easy policy stance, Brainard added. The central bank has indicated it will maintain its emergency asset purchases and hold interest rates near zero in the near term as the economy recovers. Stronger-than-expected inflation has led some economists to wonder whether a policy pullback could arrive sooner than anticipated, but Brainard reaffirmed that tightening isn’t yet on the Fed’s agenda.
“Remaining steady in our outcomes-based approach during the transitory reopening surge will help ensure the economic momentum that will be needed as current tailwinds shift to headwinds is not curtailed by a premature tightening of financial conditions,” she said.
Stanley Druckenmiller warned the Federal Reserve’s stimulus efforts are inflating a massive asset bubble, and endangering the dollar’s status as the world’s reserve currency, in a CNBC interview this week.
Here are Druckenmiller’s 10 best quotes from the interview, lightly edited and condensed for clarity:
1. “A monkey could make money in this market.” – commenting on how a wide range of assets have surged over the past year as the Federal Reserve has pumped liquidity into financial markets.
2. “I have no doubt that we are in a raging mania in all assets. I also have no doubt that I don’t have a clue when that’s gonna end. I knew we were in a raging mania in ’99, but it kept going on, and if you had shorted the tech stocks in mid ’99, you were out of business by the end of the year.”
3. “I can’t find any period in history where monetary and fiscal policy were this out of step with the economic circumstances. We’re still acting like we’re in a black hole, when in fact the economy’s accelerating.”
4. “I will be surprised if we’re not out of the stock market by the end of the year, just because the bubbles can’t last that long. I really have an open mind and right now, treacherously, we’re still playing the game to some extent.”
5. “I’m worried for the first time that within 15 years we lose reserve currency status and all the unbelievable benefits that accrued from it.” – warning that aggressive monetary and fiscal policy will make the national debt balloon, damaging the dollar’s prospects.
6. “I really don’t understand why 1.6% inflation with a mandate of price stability is a national tragedy. If the Fed wanna do all this and risk our reserve currency status, risk an asset bubble blowing up, so be it. But I think we oughta at least have a conversation about it.”
7. “The elephant in the room is inflation. It may become so obvious that the Fed has to move, and the longer they wait to move, the bigger the bubble will be and the bigger the reaction.”
8. “Five or six years ago, I said that crypto was a solution in search of a problem. That’s why I didn’t play the first wave of crypto – we already have the dollar, so what do we need crypto for? Well, the problem has clearly been identified, it’s Jerome Powell and the rest of the world’s central bankers.”
9. “The most likely replacement for the dollar would be some kind of crypto-derived ledger system invented by some kids from MIT or Stanford or some other engineering school that doesn’t exist yet.”
10. “It’s going to be very hard to unseat bitcoin as a store of value, because it’s got a 14-year brand, and there’s a finite supply. Ethereum has the lead in terms of smart contracts, in terms of commerce. But Facebook was not the first social network, it was number 11, and Yahoo may have invented the search engine, but we all know what happened with Google versus Yahoo. It’s just not probable in my mind that Ethereum is gonna be the ultimate winner.”
Does it feel like a dollar buys less than it used to? You’re not imagining things. “It’s inflation,” people sigh.
You probably have a rough idea of what inflation means. The cost of things is going up.
But what is inflation really, what causes it, and how does it affect your finances? Here’s everything you need to know about this everyday economic term.
What is inflation?
Inflation is an increase in the prices of goods and services in an economy over a period of time.
That means you lose buying power – the same dollar (or whatever currency you use) buys less, and is thus worth less. In other words: When high inflation happens, your money doesn’t go as far as it used to.
Remember that modern money really has no intrinsic value – it’s just paper and ink, or, increasingly, digits on a computer screen. Its value is measured in what or how much it can buy.
While it’s easier to understand inflation by calculating goods and services, it’s typically a broad measure that can be applied across sectors or industries, impacting the entire economy. In fact, one of the primary jobs of the Federal Reserve is to control inflation to an optimum level to encourage spending and investing instead of saving, thereby encouraging economic growth.
How is inflation measured?
Inflation is measured by the inflation rate, which is the percent change in prices from one year to another. The inflation rate can be measured a few different ways:
The US Bureau of Labor Statistics measures the inflation rate using the Consumer Price Index (CPI). The CPI measures the total cost of goods and services consumers have purchased over a certain period using a representative basket of goods, based on household surveys. Increases in the cost of that basket indicate inflation, and using a basket accounts for how prices for different goods change at different rates by illustrating more general price changes.
In contrast with the CPI, the Producer Price Index (PPI) measures inflation from the producer’s perspective. The PPI is a measure of the average prices producer’s receive for goods and services produced domestically. It’s calculated by dividing the current prices sellers receive for a representative basket of goods by their prices in a specific base year, then multiplying the result by 100.
The Bureau of Economic Analysis measures the inflation rate using a third common index, the Personal Consumption Expenditures (PCE). The PCE measures price changes for household goods and services based on GDP data from producers. It’s less specific than the CPI because it bases price estimates on those used in the CPI, but includes estimates from other sources, too. As with both other indices, an increase in the index from one year to another indicates inflation.
The PPI is useful in its ability to forecast consumer spending and demand, but the CPI is the most common measure and tends to have a significant influence on inflation-sensitive price forecasts.
The PCE is less well-known than the CPI, using different calculations to measure consumer spending. It’s based on data from the GDP report and businesses and is generally less volatile than the CPI, because its formula accounts for potential price swings in less stable industries.
Real versus nominal prices
To make meaningful historical cost comparisons – to compare apples to apples, so to speak – economists adjust prices for inflation.
When you hear a price from the past talked about in “real” dollars, that means the price has been adjusted for inflation. When you hear prices from the past talked about in “nominal” dollars, that means it hasn’t been adjusted.
Is inflation good or bad?
Inflation is certainly a problem when it comes to ready cash that isn’t invested or earning anything. Over time, it’ll erode the value of your cash and bank account. It’s also the enemy of anything that pays a fixed rate of interest or return.
But individuals with assets that can appreciate in price, like a home or stocks, may benefit from inflation and sell those assets at a higher price.
In general, economists like inflation to occur at a low, steady rate. It indicates a healthy economy: that goods and services are being produced at a growing rate, and that consumers are buying them in increasing amounts, too. In the US, the Federal Reserve targets an average 2% inflation rate over time.
When inflation starts mounting higher than that or changes quickly, it can become a real problem. It’s a problem because it interferes with how the economy works as currency loses its value quickly and the cost of goods skyrockets. Wages can’t keep up, so people stop buying. Production then stops or slows, and an economy can tumble into recession.
What causes inflation?
There’s a massive economic literature on the causes of inflation and it’s fairly complex. Basically, though, it comes down to supply and demand. Keynesian economists emphasize that it’s demand pressures that are most responsible for inflation in the short term.
Demand-pull inflation happens when prices rise from an increase in demand throughout an economy.
Cost-push inflation happens when prices rise because of higher production costs or a drop in supply (such as from a natural disaster).
Other analysts cite another cause of inflation: An increase in the money supply – how much cash, or readily available money, there is in circulation. Whenever there’s a plentiful amount of something, that thing tends to be less valuable – cheaper. Indeed, many economists of the monetary school believe this is one of the most important factors in long-term inflation: Too much money sloshing around the supply devalues the currency, and it costs more to buy things.
Types of extreme inflation
Hyperinflation refers to a period of extremely high inflation rates, sometimes as much as price rises over 50% per month for several months. Hyperinflation is usually caused by government deficits and the over-printing of money. For example, hyperinflation occurred during the US Civil War when both the Union and the Confederate states printed money to finance their war efforts.
Stagflation is a rare event in which rising costs and prices are happening at the same time as a stagnant economy – one suffering from high unemployment and weak production. The US experienced stagflation in 1973-4, the result of a rapid increase in oil prices in the midst of low GDP.
How inflation is controlled
Governments can control inflation through their monetary policy. They have three primary levers.
Interest rates: Increasing interest rates makes it more expensive to borrow money. So people spend less, reducing demand. As demand drops, so do prices.
Bank reserve requirements: Increasing reserve requirements means banks must hold more money in reserve. That gives them less to lend, reducing spending and leading (hopefully) to deflation, a drop in prices.
Supply of money: Reducing the money supply reduces inflation. There are several ways governments do this; one example is increasing interest paid on bonds, so more people buy them, giving more money to the government and taking it out of circulation.
How to beat inflation with investments
Investing for inflation means ensuring that your rate of return outpaces the inflation rate. Certain types of assets may beat inflation better than others.
Stocks: There are no guarantees with the stock market, but overall and over time, share prices appreciate at a rate that typically exceeds the inflation rate. Most index funds also post returns better than inflation.
Inflation-indexed bonds: Most US Treasuries pay the same fixed amount of interest – whose value erodes if inflation is rampant. However, with one type of bond, called Treasury Inflation-Protected Security (TIPS), interest payments rise with inflation (and fall with deflation).
Physical assets and commodities: Alternative investments – often, tangible assets like gold, commodities, fine art, or collectibles – do well in inflationary environments. So does real property: Zach Ashburn, president of Reach Strategic Wealth, notes, “returns on investments in real estate have kept up with, or surpassed, rates of inflation for many periods in the past.” That’s because these physical assets, unlike paper ones, have intrinsic value, and are sold and priced in markets outside the conventional financial ones.
More generally, Asher Rogovy, chief investment officer at Magnifina, suggests that it’s best to avoid nominal assets in favor of real assets when inflation’s on the upswing. Real assets, like stocks and real estate, have prices that fluctuate or vary freely. Nominal assets, like CDs and traditional bonds, are priced based on the fixed interest they pay and will lose value in inflationary times.
The financial takeaway
Inflation means costs and prices are rising. When they do, it means that paper money buys less. Low, steady inflation is good for the economy but bad for your savings. Ashburn says, “While having cash available is important for financial security, cash will see its value slowly eaten away by inflation over time.”
To beat inflation, don’t leave your cash under your mattress – or in any place where it’s stagnant. It has to keep earning.
Instead, aim to structure your portfolio so that it provides a rate of return – one that’s hopefully better than, or at least keeps pace with, that of inflation, which is almost always happening. If you do, it means that your investment gains really are making you richer – in real terms.
Leon Cooperman blasted the federal government for juicing a booming economy, predicted rising inflation will prompt an interest-rate hike next year, and warned markets will nosedive once sentiment shifts during a Bloomberg Surveillance interview this week.
The billionaire investor and Omega Advisors chief also blamed the Federal Reserve for investors taking greater risks, highlighted a bubble in the bond market, and questioned the need for greater regulation of family offices.
Here are Cooperman’s 11 best quotes from the interview, lightly edited and condensed for clarity:
1. “It’s the advance of greed basically. The fact that the industry would get into the same predicament again is kinda surprising. The more things change, the more they remain the same.” – comparing the recent collapse of Archegos Capital, which sparked over $10 billion of losses for the banks that lent it money, to Long-Term Capital Management blowing up in the late 1990s.
2. “I’m a retired money manager living on investment income. I run my own money. Why they have the right to regulate me is beyond my wildest dreams.” – questioning the SEC’s plans to increase oversight of family offices.
3. “I describe myself as a fully invested bear.” – Cooperman explained he doesn’t currently see the factors that cause bear markets such as accelerating inflation, a hostile Federal Reserve, and recession fears, but he expects the backdrop to change.
4. “The biggest plus out there is the Fed has created an environment where there’s an absence of alternatives.” – arguing that near-zero interest rates have pushed investors into riskier assets such as high-yield bonds, stocks, and cryptocurrencies.
5. “We are borrowing from the future. Interest rates shouldn’t be where they are, and we should not be injecting so much fiscal stimulus when the economy is growing off the charts.”
6. “The market’s gonna be surprised because the Fed will raise rates sometime in 2022. They’ll be forced to by inflation.”
7. “Everything I look at would suggest caution, intermediate to long term, would be the rule of the day.”
8. “On NFTs, bitcoin, stuff like that – I’m too old. I don’t understand that stuff, it’s crazy to me, it makes no sense. I’m a meat-and-potatoes guy, a stocks guy.”
9. “The bubble is not so much the stock market, the bubble is the bond market.”
10. “They’re not cheap stocks, but they’re not expensive stocks. Nothing is expensive if interest rates stay here.” – commenting on “big tech” stocks and echoing Warren Buffett.
11. “When this market has a reason to go down, it’s gonna go down so fast your head’s gonna spin.”
The European Central Bank kept interest rates at record-low levels on Thursday and kept its enormous bond-buying program steady as it weighed up the recovery in the eurozone economy.
The ECB’s main deposit rate will stay at -0.5%, while the coronavirus bond-buying package will stay at 1.85 trillion euros ($2.23 trillion), the governing council said in a statement.
At the bank’s last meeting it pledged to step up the pace of bond purchases in response to rising bond yields.
COVID-19 battered the eurozone economy in 2020, and a resurgence of cases has led many countries to reimpose tough restrictions in 2021.
But policymakers and citizens see hope on the horizon. The European Union’s initially slow coronavirus vaccine rollout is picking up pace and the International Monetary Fund has upgraded its growth forecast for the eurozone in 2021 to 4.4%, after the economy shrank 6.6% in 2020.
The European Central Bank’s decision to hold interest rates came as no surprise to analysts.
“Vaccination numbers within the euro area are beginning to pick up pace, providing hope that economies will soon be able to start the reopening process,” Mohammed Kazmi, portfolio manager for Swiss private bank UBP, said.
He added: “We think it makes sense for investors to start preparing and positioning for the June ECB meeting, which will likely be accompanied by significant growth revisions higher and [bond] purchases for Q3 probably moving back towards a more normal pace.”
The euro was around 0.1% higher against the dollar on Thursday at $1.204, while the yield on the key German 10-year government bond had risen 0.9 basis points to -0.250%.
The Turkish lira fell as much as 14% on Monday, after President Recep Tayyip Erdogan sacked the head of the central bank, Naci Agbal. Investors fled Turkish assets after Agbal’s departure, whose appointment had increased confidence and trust in the country’s monetary and macroeconomic policies.
Since Agbal’s appointment in November 2020, the lira had regained some strength and stability, as domestic and foreign investors responded well to his more traditional macroeconomic policies. Previously, Turkey’s unconventional approach to monetary policy had made many investors cautious and the lira suffered as a result.
Agbal raised interest rates to 19% from 17% on Thursday. The rate hike boosted the currency, but went against Erdogan’s belief that higher interest rates raise inflation. Agbal’s replacement, Sahap Kavioglu, shares this opinion.
“Mr Agbal’s replacement, Sahap Kavcioglu, is a little-known business school professor who shares President Erdogan’s economics theories and is, unsurprisingly, associated with the ruling party. Turkey will be an interesting example of what EM can expect if inflation fears rise markedly, with markets nervous about inflation in developed countries and punishing asset classes accordingly,” Jeffrey Halley, senior market analyst at OANDA, said on Monday.
Turkish finance minister Lütfi Elvan has however stated the country will continue to follow a policy of free markets and a liberal foreign-exchange regime. A statement by Kavioglu also said the Turkish central bank “will continue to use the monetary policy tools effectively in line with its main objective of achieving a permanent fall in inflation”.
The falling lira dragged on the benchmark Borsa Istanbul 100 index, which tumbled by as much as 9% on Monday, as investors fled the domestic market.
The heightened nervousness of fixed income investors was also reflected in the stark price fall of the benchmark Turkish 10-year bond. Its yield rose by as much as 300 basis points to around 16%, on Monday, its highest since August 2019. Yields move inversely to prices.
Growing concerns over economic and currency instability following Agbal’s dismissal, especially relating to shifts in interest rates and inflation, have raised the risk associated with Turkish assets and led investors to pull out of Turkish markets across the board on Monday.
The long-term strength of the Turkish economy and the lira are now in jeopardy, Rabobank senior emerging-market strategist Piotr Matys said.
“Essentially, the risk that the CBRT could make the same policy mistake as in 2019/2020 is high. To reiterate the point we have made on numerous previous occasions, Turkey cannot afford to have negative real interest rates when inflation is substantially above the official 5% target,” Matys said.