Last night the Turkish Central Bank raised interest rates from 7.75% to 12%, in an attempt to protect the Turkish lira. The current Turkish Government’s Finance minister was obviously not around in 1992, to watch Norman Lamont’s attempts to shore up the British pound in a similar manner.
In 1990 sterling joined the Exchange Rate Mechanism, it was the building blocks from what eventually became the euro. The ERM was introduced in 1979 with the aim to reduce exchange rate variability. Each currency within the ERM was to remain within a band, but could fluctuate within the band. From memory, the main problem sterling suffered from was staying within the strength of the deutschemark. On the 16th of September 1992, in an attempt to keep sterling in these bands, the Bank of England bought pounds, and then raised interest rates quickly. At one point UK interest rates reached 15% on the day. The outcome everyone remembers, sterling came out of the ERM and found its natural level, the following year the economy started to recover.
Many traders that day made a name for themselves as they shorted sterling, knowing that whatever the Government tried to do the markets would win. They knew trying to buck the market is usually bound to failure.
Overnight the news that the Turkish Government has made moves to shore up the lira by raising interest rates. This calmed markets briefly, and the lira rallied for a time against the US dollar, but sadly rather like sterling in 1992, that did not last long and the lira is back to the level it was before the rate hike.
The cause of the turmoil is money being withdrawn from emerging markets and returned to the US dollar as rates of return increase in the US. We have seen long US bond rates fall in the past 2 weeks, as investors lock in higher rates seen at the start of the year. On top of that, as the emerging markets worries intensify, caused by the repatriation of capital, investors are now also buying US treasuries as a flight to safety, pushing yields down further.
The irony being that as yields fall, the returns become less attractive, this could discourage investors taking money out of out of riskier assets with higher returns, for example emerging markets. A balance will be found but it will take time. This is another reason why interest rates will not rise for some time to come.
The conclusion I have is whatever the Fed does with their bond purchase program on Wednesday, within reason, it will have no overall impact on US treasury yields as the market decides the price, not the Fed.