A Central Bank Story That Could Turn out to Be Bigger Than the Fed

The news this morning is dominated by talk of the Fed’s somewhat predictable seventy-five basis point hike in rates, and in the world of financial news at least, by a rush of other central banks following suit. There is, however, one country that is bucking the trend. Turkey’s central bank announced this morning that they are cutting their benchmark rate by one percent. The move is surprising in some ways, but not at all in others, and could, in the long run, be more significant to investors than the Fed’s actions.

It is surprising because it goes against any kind of economic orthodoxy. Rate cuts are generally seen as inflationary and are used to promote growth when price rises are under control, or sometimes to combat currency strength that has gone beyond what is considered desirable. That is far from what is happening in Turkey, where the August data showed prices rising at an annual rate of 80.2%. That marks the fifteenth consecutive month of rising inflation and puts it at its highest mark this century, and the Turkish Lira has lost 80% of its value versus the dollar over the last five years.

So, with rampant inflation, a collapsing currency and dwindling foreign exchange reserves, why would the Turkish central bank cut rates? The answer is because the decisions on rates there are not made based on economics, but rather on politics. Turkish President Recep Tayyip Erdogan has said loudly and often that high interest rates are “the mother of all evil,” and that cutting rates is a way to fight inflation. It is unclear quite why he believes that, but he keeps doubling down on it and he is not someone known for backing down or admitting that he was wrong. Bankers and economists have tended to think otherwise, of course, which is why Erdogan struggled to find a central bank governor that he likes, firing three in a two-year period up to last spring as he was formulating his “putting out a fire with gasoline” theory.

This is a lesson in why maintaining central bank independence is so crucial, but there are less theoretical, more direct implications for investors outside of Turkey if it continues. Whether we like it or not, we live in a global economy, and a massive collapse in one country rarely stays contained for long. Erdogan presumably knows that, and one explanation for his seemingly illogical, almost suicidal behavior here is that he believes that the global implications of his actions will play to his advantage.

Turkey is strategically important, geographically and culturally. It is a buffer between Europe and the Middle East, and it is a NATO country with close ties to Russia. That importance has led to investment in the country from all sides and it could be that Erdogan is assuming that that has made the country “too big to fail” for almost every bloc in geopolitics. He may be right, but even if he is, what looks like a dire situation there will ripple through markets when it comes to a head. Governments, banks and other corporations will have exposure, and given the geopolitical importance of the country, it would be no surprise if in some cases that turned out to be larger than might seem prudent.

So, over the next few weeks and months, as we read watch and hear endless coverage of the Fed, keep an eye on the situation in Turkey. It might not seem to be as relevant to you and your investments, but real turmoil in markets rarely comes from the place that everyone is watching. The economic situation in Turkey is a risk factor that could emerge from the shadows quickly and with a huge impact.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Central Banks Policy & Regulation