‘Thwarting This Game Together’: Of Burnt Turkey, Emerging Markets And Dollars Under Pillows

Listen, there’s a time and a place for unhinged rants about international conspiracies aimed at engineering a domestic currency crisis, and if you’re Turkish President Tayyip Erdogan, that time is every time he opens his mouth and that place is wherever he happens to be speaking.

Heisenberg regulars know I spend an inordinate amount of time talking about Erdogan and Turkey more generally and while I would argue that’s always time well spent considering the country’s pivotal role in regional affairs and tenuous relationship with the West, keeping abreast of Erdogan’s ongoing quest to consolidate power and solidify his dubious place in history serves me well whenever EM grabs center stage in the market narrative.

If you’re following along, you know that the key question for EM as the Fed tightens, as the dollar rallies and as U.S. yields rise, is this: are recent stumbles primarily attributable to idiosyncratic stories in Turkey and Argentina or does that characterization get the causality wrong? That’s actually two questions. If the answer to the latter question is “yes”, well then what’s really going on is that the external shock from a determined Fed, a stronger dollar and rising U.S. rates is the controlling factor and the crises in Turkey and Argentina represent what happens when a shift in the macro environment begins to weigh on the EM complex more generally.

That is, it’s not that the idiosyncratic stories in Turkey and Argentina just happened to come to boil at the exact same time the dollar began to rally, U.S. yields reached a tipping point and the Fed came under new leadership; rather, it’s that Turkey and Argentina were simply the wobbliest dominoes and were thus first to fall when the external environment took a turn for the unfavorable.

The fact that Bank Indonesia was forced to hike rates for the first time since 2014 this month and that during the same week, the BCB eschewed  what would have been a 13th consecutive rate cut in an effort to put the brakes on the currency pressure, clearly suggest the market is concerned with the prospect that Jerome Powell was at least a little bit off base when he said “the normalization of monetary policy in advanced economies should continue to prove manageable for EMEs” at a recent IMF/SNB event.

Here’s Barclays:

In Indonesia, officials have warned that the IDR is “too far from its fundamentals“,  pledging to continue dual intervention in the FX and bond markets (Figure 3), and stand ‘ready to adjust policy rate in future if needed’ after a pre-emptive rate hike by Bank Indonesia. Brazil’s central bank has stepped up intervention in FX swaps to curb BRL weakness, and has indicated willingness to do more.

In short, the rupiah is in trouble, so is the Brazilian real, and for those who want the 30,000 foot take complete with a chart buffet from the week Indonesia hiked and BCB paused, you can check out “‘We Might Have To Cut ‘Em Loose’: There Are Worse Things In The World Than An Emerging Market Rout, Right?“.

In the week ahead, “the market will be on alert for strong policy responses by EM central banks to curb FX volatility,” Barclays writes, in the same weekend note cited above, adding that “EM currencies, in particular those belonging to economies highly reliant on external funding, have come under most pressure in the latest USD upswing.” Here’s a YTD snapshot:

Coming full circle to Erdogan, he was on the tape over the weekend with some characteristically absurd comments about exactly what it is that’s behind the lira’s ongoing collapse.

Speaking in the country’s eastern Erzurum province (remember, he’s “campaigning” ahead of the election which was brought forward by some 18 months), he implored his countrymen to ignore what he’s calling “rumors” about the currency and the economy because – and this is quote – he “sees the game that is being played [and] is confronting it with the tools at hand.”

Now, for one thing, he is in fact doing exactly the opposite of “confronting” the currency situation “with the tools at hand.” There are a number of “tools at hand” and CBT isn’t allowed to use any of them other than LLW hikes.

On Wednesday, following a truly harrowing series of events that saw the lira plunge to a new all-time low after Mrs. Watanabe was stopped out in TRY/JPY overnight, CBT attempted to stop the bleeding with an emergency 300bps LLW hike. That was the second late liquidity window hike in a month and despite being far larger than the April 25 move, it wasn’t enough to arrest the slide. Here’s a kind of slapdash chart that’s sufficient when it comes to showing you how ineffective the 75bps hike from late April was and how fleeting the respite was from this week’s effort:

Ok, so as you can see from that second red box, the market immediately faded Wednesday’s emergency action which means CBT will likely need to do something else at their official meeting on June 7 – unless of course Erdogan can engineer some kind of popular revolt against the dollar and the euro internally which is precisely what he tried to do in the same Saturday speech mentioned above.

“We will spoil this game together”, he continued, referencing his contention that the lira’s woes have nothing to do with his own perverse “theories” about interest rates (which are the only thing Erdogan hates as much as Fethullah Gülen), nothing to do with the fundamental backdrop (see here), and everything to do with an international “game” being conducted by nefarious forces who are jealous of the Turkish economy.

And how will Erdogan and regular Turks “spoil” the plans of global bad actors? Well, that’s simple. Here’s Erdogan:

My brothers who have dollars or euros under their pillow. Go and convert your money into lira.

He also threatened “the finance sector”, which he accused of “playing games”. If those “games” continue, Erdogan says the folks “playing” them will “pay a heavy price” (hopefully in dollars or euros, because if they “pay a heavy price” in TRY, that payment won’t be worth much to whomever it’s paid).

Of course every time he says that shit it just makes global investors even more nervous about what comes next and with the possible exception of “White House Press Secretary”, I’m not sure there’s a job I would want less than “CBT official” right now.

“If the TRY continues to sell off, we think the CBT could raise all policy rates of the interest rate corridor at the upcoming MPC meeting on 7 June,” Barclays writes.

I guess. But again, you have to ask yourself whether that’s feasible. This is one of those situations where even if you can convince the person in charge to let you do something you know is necessary for the greater good, it’s not clear it’s in your personal best interest to go through with it. That is, even if Erdogan lets CBT do what they need to do, he will invariably be irritated with anyone who pushes for aggressively tight monetary policy.

So if you’re CBT what do you do? The utilitarian in you says do what’s right to save the currency, but self-preservation might just entail doing something half-hearted in the interest of appeasing a man who just a week ago called the very tools you’re being called on to use the “mother and father of all evil.” If high rates are the “mother and father of all evil” in the eyes of a genocidal maniac with absolute power, then what does that make people who hike rates? At the very least, it makes them nervous as hell about doing anything that might piss off the autocrat.

At the end of the day, it’s impossible to disentangle these kind of country-specific stories from weakness in the broader EM complex catalyzed by the Fed, dollar strength and rising U.S. yields. But one thing is abundantly clear: as funny (in a tragicomedy kind of way) as the Erdogan story is, his unorthodox views on rates, FX and inflation are hardly new. What’s new is the resurgent dollar, nominal 10Y U.S. yields at their highest since 2011, real rates in the U.S. at taper tantrum peaks and a Fed that’s taken a turn for the data dependent.

How all of this plays out is anyone’s guess.

I suppose we will, to quote Erdogan, “thwart this game together.”