Thoughts on USDJPY

Following on the same theme as our previous post on looking to get short GBPUSD on the current bounce, we expand on one of our themes, namely Dollar strength with a view to risks to the upside into Q4.

We would look to buy USDJPY (in addition to selling GBPUSD) to express this.

US 10year yields are looking at a potential break above 1.63%, which may correct the year long move lower in yields. This combined with the Bank of Japan taking a far more active role in the health of the Japanese banking sector (after many banks were left in trouble following their rate cut earlier this year – amongst other things) is in itself positive for both the Nikkei and USDJPY.

The September 21st FOMC meeting (which is currently pricing in a 20% chance for a hike) and the subsequent statement could add further upside stimulus to USDJPY. We feel December to be the most likely timing for a rate hike, as data for a September meeting rate hike, has not been strong enough. This combined with with US Elections, makes a September hike increasingly unlikely, and sets the market up for a December hike. The resultant effect on Japanese institutions could be to return to unhedged UST holdings, which again would help USDJPY.

Entry levels to bear in mind are around 101.50-102.00 (the bound of the recent move lower  on the 3rd of September) but we would look to build slowly into this position, as we have plenty of time on our side for this trade.

Introduction

It has most certainly been an interesting summer, though arriving back in London and speaking to some of our clients, we have been taken aback by the perception gap which exists surrounding Turkey and the failed coup of the 15th of July. There is little doubt, that a cognitive chasm between many in the Western and Muslims worlds now exist, when it comes to upholding ostensibly universal values surrounding democracy and self-determination (The New York Times labelled the popular defence of democracy a ‘counter-coup’ and described the millions of citizens who defied death as being akin to Erdogan’s ‘sheep’).

Standard tropes as have been peddled by Western news outlets do very little to assuage matters. At Salonica, we take pride in our objective analysis of geopolitical events and the implications for the macro economy. However, in this brief piece we have extended our hermeneutic framework to explain some of the actions and reactions we have seen in the near past to give a concise overview of what has occurred and some thoughts going forward.

Coup and Apathy

One should not underestimate the brevity of the events which occurred on the 15th of July. Fortunately, I was nestled away in a sleepy town in the Anatolian north, however colleagues and friends were in Istanbul and Ankara. My initial reaction was of total incredulity – a sentiment shared amongst the general populace (though many of the coup plotters were being investigated by the government, something which prompted them to hastily bring forward their nefarious plans) – and was of the view that coups, like the plague and hyperinflation, were a thing of the distant past. Seemingly not so.

It is truly stupendous and a great testament to the will of the Turkish people that the coup could not succeed, (though we are no longer in the era of coups and counter coups – for example in Syria during 1949, when no less than 3 ‘successful’ coups occurred), as a coup not succeeding is an aberration as opposed to the norm. However, for long time Turkey watchers such as ourselves what has been more shocking, is the lack of condemnation or sympathy from Western governments and media outlets, with sceptics shrugging it off as ‘an inside job’.

This is what Soli Ozel a political scientist and journalist said of the reaction thus far:

“Both EU politicians and Western media outlets preferred to see July 15 only in the context of the previous political developments. They neglected the invaluable democratic assistance shown by all political parties in a parliament bombed by war planes. That no one came to Turkey from EU institutions (with the exception of a UK minister) to offer solidarity with the Turkish parliament, the founding institution of the nation, shows a lack of sensitivity, empathy and solidarity that cannot be easily digested.”

Ozel is no pro-Erdogan ‘Islamist’. He is a Turkish Jew, a secular liberal and an outspoken critic of the Erdogan regime. The lack of empathy is a missed opportunity and would have signalled to the AK Party government that despite recent differences the West stands united behind the democratically elected government of Turkey and respects the will of its people. In the US, a number of American politicians and networks experts could scarcely suppress their glee over the thought that the Turkish government would be overthrown by a General Sisi type junta in Turkey, which would ‘serve American interests’.

A rare Western leader who grasped this key point was Carl Bildt, the former prime minister of Sweden, who recently wrote a notable piece, “Europe, Stand up for Erdogan.” explaining the severity of the coup attempt and criticised Western institutions for only focusing on the anti-coup measures. “Europe risks losing its moral authority if it does not appear particularly engaged in dealing with the coup itself.”

Foreign Relations

Instead Russia and Iran – both of whom were recently at loggerheads with Turkey – in their swift condemnation of the coup – prior to when it became apparent who the winner would be – have now endeared themselves to Erdogan, and crucially the Turkish people as we now revert to a pre Nov 2015 situation

Of course the rapprochement could not have occurred without Erdogan’s ‘letter of regret’ to Putin in June of this year, however the swiftness of the normalisation – accelerated by the failed coup – is a clear indication that normalisation of ties has been on the cards for a while.

While some commentators are now saying that Erdogan’s sudden obeisance to Putin is an illustration of an internationally isolated Turkey dancing to a Russian tune, that is to negate two key principles of the AK Party leadership, firstly the continual balancing act Turkey has to play due to its sensitive geography and secondly Erdogan’s astuteness in playing both sides off against each other. The fruit of which has been the entrance of Turkey into the Syrian war.

Entering the Fray

Since the appointment of Binali Yildirim and rapprochement with Russia, there seems to be a shift in Turkey’s Syria policy, which has softened its position regarding the role of President Assad, as both Assad and Erdogan are equally concerned about the increasing autonomy of the PYD in Syria. For Turkey, who maintain – with credible evidence – that the PYD is affiliated to the PKK, the twin threats of Daesh and PKK terrorism are greater concerns than the removal of President Assad.

Therefore, On August 24th the Turkish military, flanked by Free Syrian Army (FSA) fighters, entered Syrian territory taking control of the border town of Jarablus from Daesh and has since cleared the entire border region of Daesh. The operation was also intended to prevent the YPD, whom Turkey deems to be affiliated to the PKK from taking Jarablus, extending their control in northern Syria after taking Manbij, to the south, on August 12th.  Turkey’s action had US support in the form of intelligence and air strikes on Daesh positions during the operation but there is limited backing against further advances on the YPD, though Erdogan on his way back from the G20 summit in Hangzhou did speak of the potential for a joint Turkish-US operation to liberate Raqqa from Daesh.

Iran

How will this work with Iran, as my esteemed colleague back in May argued eloquently for the deepening of a Saudi-Turkish alliance? While Iran swiftly came out in condemnation of the coup, Turkey views Iran through the prism of Russia. Bilateral trade ties, while growing, are still dwarfed by trade with Russia, Germany China and the US and therefore the economic ramifications for poor political relations are not as acutely felt as with Russia for example. One important development is the joint stance on Kurdish autonomy (though some analysts are suggesting that Turkey has stirred the hornet’s nest of Iranian Kurdish independence in order to force them onto the same page as Turkey) which has forced Turkey, the Sunni Arabs and Iran to sing from the same hymn sheet with regards to the unity of The Syria State and abhorrence for any type of regional autonomy.

Foreign Policy Risks

Concerns still exist with Iran, in particular the its support for the Assad regime and sectarian policies in the region – Turkey was quick to repopulate Jarablus with Arabs and Turkmen after its capture. Furthermore, reconciliation with Moscow can only go so far, Turkey and Russia remain at odds in the Caucasus and in the Black Sea, which President Erdogan recently described as on the verge of becoming “a Russian lake”. Turkey also resents Russia’s habit of allowing home-grown jihadists to travel to Syria. Such concerns have grown since the attack by IS militants on Istanbul’s main international airport on June 28th when two of the suicide bombers involved, as well as several suspected accomplices, turned out to be Russian nationals.

Ultimately, the warming of Turkish, Russian and Iran relations will only be beneficial to the future stability of the Middle East, as economic co-dependence is always a good roadblock for marked deterioration in relations.

Economy

Financial market nervousness rose post-coup although, given the seriousness of events, not by as much as expected. The lira, which was trading at about TL2.88:US$1 before the attempted coup, stood at TL3.08:US$1 on July 21st, though it quickly recovered. Share prices on the Borsa Istanbul fell by 9.6% during the same time though it has again, recovered much of those losses.

Turkey’s investment risk profile has suffered too (Rating agency Standard & Poor’s changed the country’s outlook to negative as a result of the coup), the pain felt here could be acute as the economy depends heavily on continued inflows of foreign capital to finance its perennially large current-account deficit, currently running at about 4.5% of GDP.

However, the Central Bank announced a series of precautions to ensure the continued effective functioning of the banking system, including a promise of unlimited liquidity to banks and thereafter on July 19th the Monetary Policy Committee (MPC) of the Central Bank continued its recent round of interest rate cuts, reducing the overnight lending rate, which marks the upper bound of its interest rate corridor, by a further 25 basis points, to 8.75%. The bank has now reduced the corridor ceiling by a total of 200 basis points since March.

Previous rate cuts are part of a normalisation process of narrowing the interest rate corridor with a view to restoring a single policy rate. The decision to cut rates by only 25 basis points rather than the 50 announced at the previous three MPC meetings may have reflected the bank’s caution following the failed coup and the uptick in the annual rate of consumer price inflation to 7.6% in June

Two months on, Turkish financial markets performed reasonably well though Turkish banks have postponed investors meetings and bond settling transactions as they try to weather the state of affairs.
The lira has bounced back from the lows post-coup, currently at around 2.95 Lira to the $.

As Turkish Deputy Prime Minister and former Minister of Finance Mehmet Simsek says “The commitment is that we will maintain sound, rational macroeconomic policies. We will stick to market economy… It has done phenomenally well in the past and the Turkish economy has proved itself to be fairly resilient in the face of various shocks.” Nevertheless, investors remain cautious have adopted a wait-and-see attitude.

US Uncertainty Helping Emerging Markets

Fortunately, US interest rate rises are currently on hold and global liquidity conditions remain loose. Furthermore, continued poor data – last week’s non-farm payrolls were dire – has helped Emerging Markets in particular, and under such circumstances Turkey has been having little difficulty in attracting the capital inflows it needs to avoid currency weakness, higher inflation and a decline in economic activity. We expect these global conditions to continue which will give Turkey some time to restore stability and confidence.

While there are downside risks to the lira, we feel it will be range bound 2.8-3.2, though we feel the Central Bank may limit itself to one more 25-basis-point cut in the overnight lending rate, as otherwise it runs the risk of increasing inflationary pressures.

The tourism sector’s direct contribution to the economy is approximately 4.5-5% of GDP (this rises 12% if one includes the indirect impact) and accounts for about 2.5% of employment (about 8% in total). Therefore, the variety of shocks over the past 12 months – the result of which has been occupancy rates falling by 40% in Q1 2016, and year on year travel by Russians and Germans (two of the largest foreign tourist groups) to fall by 90% and 30% – has had an effect on GDP. Security concerns have also highlighted the risk of disruptions to international air travel and their related negative effect on the local business environment, with flights pared back in July.

However the restoration of trade links with Russia, has provided much needed relief to the tourism sector and will offset losses seen from Western European tourists who have been put off by the spate of terrorist attacks.

Furthermore, flight traffic and passenger turnover through Istanbul Atatürk Airport has markedly improved over the past few weeks, with a total of 1,454 take-offs (corresponding to around 142,000 passengers) and landings from its runways, setting a new air traffic record for the airport on Sept. 4, Doğan News Agency has reported.

Anti-Gulen operations: A risk to local businesses

The crackdown on the Gulenist networks in Turkey has been ongoing since 2013, for example in May 2015, the government seized control of Bank Asya, a Gulen-associated participation bank, while in March 2016 the government took control of the Zaman newspaper. While these may illustrate an unnerving degree of state intervention, it is interesting to note, that it is only Gulenist networks that have been targeted, otherwise the state has kept out of interfering in private business. Despite this, the seizure of Gulenist business has created risks, and is a concern for the banking sector ($1.4 billion NPLs at risk) according to Canikli a deputy PM.

Financial instability overall

The worst of the purge seems to be over, but more seriously the removal of thousands of civil servants and military officials and their eventual replacement with new employees and cadres will affect the quality of government services, crucial for a well-functioning economy. Normal operations in some ministries might be affected during this purge and replacement period.

The AK Party owes much of its electoral success in the past decade to its ability to improve Turkey’s economy, particularly in Anatolia. The top brass of the Party are concerned about the adverse impact of the coup and its aftermath on Turkish economy and have given top priority to economic issues. This priority has already been demonstrated by the quick and effective measures in the immediate aftermath of the attempted coup calmed the capital markets – the Lira plunged to a record low against the Dollar and investors dumped equities in the biggest sell-off since 2008 – without imposing any capital controls.

The Government is preparing a major economic reform package to further improve the business environment as Turkey is returning to a business-oriented foreign policy. This includes a new announcement by Russian Economy Minister Alexei Ulyukaev who commented that on the 4th of September, President Putin and his Turkish counterpart Erdoğan had agreed to form a joint investment fund between their two countries. ‘We are concluding work on the formation of a Russian-Turkish investment fund,’ Ulyukaev said. ‘At the end of August, Turkey made the necessary legislative changes to create a corresponding partner to our direct investment fund – the Turkish sovereign wealth fund…I think by some time in October or November we will have a list of projects and allocate a credit line to begin work.’

Elsewhere, the announcement by Prime Minister Binali Yildrim of an investment and development package for eastern and south eastern Anatolia regions was welcomed by the tourism sector and business lectors. Tourism sector representatives think that investments to be made in eastern and south eastern Turkey will turn the region into a touristic attraction centre. Turkish Travel Agencies Association (TÜRSAB) President Başaran Ulusoy told Anadolu Agency that the investment package is crucial for the economic invigoration in eastern and south eastern provinces. Apart from building hospitals, homes, infrastructure, logistics and education worth nearly 10 billion Turkish Liras ($3.4 billion), the government also plans to provide huge incentives to new real sector investments in the region in the form of free-of-charge factory sites, zero-interest machinery loans and guaranteed purchases, pushing the overall size of the package to $140 billion.
These are positive steps that will benefit Turkish economy in the long run, although the terrorism risks to tourism and investor confidence that existed before the coup are likely to continue in the new environment as well. However, the government must also be very mindful of how its cultural, political and security decisions in response to the coup will affect the economy.

Therefore, while challenges remain, current GDP forecast for growth is expected to be 3.5% for 2016 and 3.8% for 2017, according to The Economist.

Turkophobia

Some of the points above, raise the far deeper deeper question of Turkophobia which seems to have infected both the left and right of Europe. Otherwise respected journalists such as Robert Fisk, seem to have a blind spot for Turkey, seemingly incapable of reconciling the complex geographies, identities and histories which abound in Turkey. Yet others view Erdogan’s post-coup crackdown, as a general purge of all political opponents. However, this is to disrespect the Turkish people who like the abortive coup, and who would not stand for such injustice. The fact is that the Turkish crackdown and removal of civil liberties is no more extreme than what has occurred in France post 13th of November 2015. However, condemnation of the French position has been damningly silent. Furthermore it doesn’t take account of the fact that a number of journalists who insulted Erdogan pre-coup have not been prosecuted.

Sobriquets of “neo Ottomanism” and “Sultan” are haphazardly thrown around, perpetuating lazy orientalist myths which no longer apply. The AK party just happens to be populated with conservatives who would like the freedom to practice their faith more openly and freely – Kemalist secularism is more rabidly lacite then the French incarnation. This also happens to reflect the will of the people, many of whom still hold a religious world view. A recent poll conducted suggests that Erdogan has 70% approval ratings, figures Western democrats can only dream of. For all Erdogan’s shortcomings, his country isn’t a dictatorship nor is he a fascist or an Islamist. He has neither stolen elections, nor launched pogroms against the Country’s Kurdish or Alevi communities. He has a peerless electoral record and if anything, his popularity is bolstered by his authoritarianism, which has also calmed the markets.

Over the past 13 years, the economy has taken enormous strides. The proportion of people below the official poverty line has fallen from around 30 percent of the population in 2002 to less than 2 percent. Life expectancy, years of schooling, output and formal employment have all gone up at respectable rates. Growth recovered well after the crash of 2008, which is all the more remarkable given the continued travails of many G10 economies and Turkey has been steadily closing the gap with the world’s advanced economies.

As Christopher de Bellaigu commented:

‘Words often change meaning when they change language. If Erdogan is correct to suspect that the US and EU would not have mourned his overthrow, this is because he now presides over a bespoke form of government that western leaders do not understand or appreciate. Erdogan’s demokrasi may be “illiberal” in its practice, but it represents a forceful expression of the people’s will – a blunt majoritarian riposte to an imagined democratic gold standard that in reality no longer exists.’

There is still much to do, per capita incomes stand at less than half of the industrial-country average, and inequality is high. A persistent external deficit underlines the need to make Turkish producers more efficient. The AK Party has been an effective economic reformer. Recent policy announcements promise new spending on infrastructure – the completion of a third bridge linking Asia and Europe is another feather in the cap –  and ministers acknowledge the need for more ambitious structural reforms, to reduce pressure on the central bank, increase transparency and deal with corruption which are all long standing issues were holding Turkey back even before the attempted coup. In this respect the dismissal of civils servants will affect the prospects of reforms. Even from an operation perspective the dismissal of some 1,500 officials at the Ministry of Finance has raised concerns about the day-to-day management of the public finances at a time when the central government budget deficit looks set to exceed the government’s target of 1.3% of GDP for 2016.

Gulen

The Gulenists have been portrayed variously as a kind of cuddly capitalist, spiritual Muslims, embodying the Protestant work ethic and value for hard work. In 1999, two years after the army ousted a conservative prime minister, Gulen left for America, and soon thereafter, he was charged in absentia with subverting Turkey’s secular order. A videotape showed him urging followers to seize control of the state, “You must move within the arteries of the system, without anyone noticing your existence,” Gulen said on the tape. “You must wait until you have all the state power.” seemed to confirm fears held by authorities at the time. The Gulenist and AK Party dalliance was nothing more than a mere marriage of convenience. A temporary marriage that should never had occurred and which some AK Party acolytes warned against at inception, simply because of their shadowy beliefs.

Furthermore, Gulen was never lauded by the traditional religious scholastic class of Turkey – the inheritors of Ottoman orthodoxy – as Gulen had never undergone any rigourous religious training. He is another one, in a long line of self-proclaimed scholars which have intoxicated minds and created instability and confusion in the Middle East.

American vice president Joe Biden drew an analogy between the the failed coup to the terrorist attacks of 9/11 and Erdogan seems to have formulated his own 9/11-esq response: You are either with us or against us – and by extension with the Gulenist Cult, “The United States has to choose either the Gulenist terror cult or Turkey.”

Thus, Gulens acolytes who run a number of missionary schools and mosques in Africa and South Asia have come under immediate pressure, with the Sudanese government closing all Gulen affiliated schools down and Pakistan soon to follow suit.

What happens to Gulen himself is uncertain, as Turkey has formally submitted evidence to the US government implicating Gulen in the coup. At the moment the US is currently deliberating on the information at hand. What will be interesting is if the US extradited Gulen to Turkey. If not, will the Turks engage in the type of extra judicial killings that have been a hall mark of US foreign policy over the past few decades?

Some Thoughts Going Forward

In every crisis, there is hope, and out of every crisis the victor always emerges stronger, and it is fair to say that Erdogan has a mandate which far outstrips anything he has had previously. Perversely the coup certainly makes the case for a Presidential style of leadership, with a strong central command. At the moment, he enjoys strong cross party support. However, the continued war with the PKK is taking its toll. Attacks are continuing and we could revert to a situation circa 1980s, of a low intensity war which will cripple the south east. This makes the Syrian context vital, and the removal of the PYD critical. However, Erdogan must reach out to Kurdish civil liberties groups and partners for peace and look to a way of reconciling himself with Kurdish constituents who do not wish to accede but merely to share in the same uplift in living standards that have been experienced across the rest of the country. In this regard given Turkeys – and Erdogan’s – close relationship with the KRG , it is surprising to see that they have not been asked to remediate this, seemingly sequestered away with their own issues.

Turkish hard and soft power continues to increase, and it is now likely that Turkey will maintain – in the short term at least –  a forward military base in Jarablus, similar to the one in Northern Iraq. Though, a real concern is the result of continued purges, particularly in the Army which risks reducing operational capacity at a time when Turkey is fighting Daesh and the PKK/YPD on separate fronts.

Despite the events of the summer, Turkish corporates are refreshingly optimistic. Fiscal discipline and the strength of the banking sector will continue to be the fundamental elements of Turkeys economic stability. GBPTL is firmly in the 3.80-4.00 range, any break out to the upside, we feel is a sell opportunity. Look to enter shorts at around 4.15/4.20, with a move back down to 3.80.

Investors from the GCC and Asia continue unabated, with Dubai based Abraaj Group raising $526m for investment in Turkey, which was notable for its diverse investor base. This seems to be confirmed by Moody’s Investor Services, which reported that the credit profiles of most non-Turkish companies from the EMEA region with operations in Turkey will be largely unaffected by the political uncertainty in the country, another boon.

The Turkish economy has been going through a period of adjustment for a while, and the government thus far has responded decisively to the most recent crisis. The state of affairs is fragile, however rapprochement with neighbours, and continued opening of new markets as well as restoration of old ones as well as US policy softness should give Turkey some breathing space as it looks to catch its breath into the new year.

For more information on any of the above please call through to us on +44 207 268 4869

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