As Trump, Pence Threaten Turkey With Sanctions, It’s Time For Markets To Accept The Reality Of Erdogan

On Thursday, Neil Mellor, a senior currency strategist at BNY Mellon, told CNBC the following about the outlook for Turkey and, more specifically, for the beleaguered lira:

It’s difficult to see a silver lining at present because the recent rise inflation has been fairly dramatic, and some signs of stabilization will be necessary before the market can heave a sigh of relief.

As far as the lira is concerned — well, as the old saying goes, don’t catch a falling knife.

You can count this guy (me) incredulous at this point. This is one of those situations where it’s not clear whether to cheer the fact that everyone seems to be waking up to reality or whether to be aghast at the fact that it’s taken this long for ostensibly smart people to state the obvious.

In scenarios like that, I’m almost inclined to just not put digital pen to digital paper because my incredulity ends up manifesting itself in withering sarcasm, but on Thursday, my pen was forced when Vice President (and human-mayonnaise hybrid) Mike Pence threatened to slap Turkey with sanctions in an effort to secure the release of North Carolina evangelical Christian pastor Andrew Craig Brunson.

If Turkey does not take immediate action to free Pastor Andrew Brunson and send him home to America, the United States will impose significant sanctions on Turkey until this innocent man of faith is free. pic.twitter.com/GM9WohpMRm

— Vice President Mike Pence Archived (@VP45) July 26, 2018

I don’t want to trivialize Brunson’s plight, but on the other hand, this situation is just another episode in the long running reality show that is Recep Tayyip Erdogan’s never-ending quest to get his hands on Fethullah Gulen, who Erdogan blames for everything under the sun including, of course, the failed coup attempt in 2016. For good measure, Erdogan also claims Brunson is allied with the PKK, which is second only to the Gulenist “movement” when it comes to people Erdogan hates.

Erdogan has been trying to get his hands on Gulen for years, allegedly going so far as to try and convince Michael Flynn and his son to kidnap the Pennsylvania-based cleric in exchange for $15 million.

You can trace this story back as far as you want to, but just to underscore how convoluted it is, do note that Erdogan has long claimed that Gulen has links to Preet Bharara. In a conversation with then-Vice President Joe Biden, Erdogan accused Bharara  of being “a Gulenist tool” and demanded that Biden have the then-U.S. Attorney fired. Of course Bharara was ultimately fired, only not by Joe Biden – rather by Donald Trump.

It goes well beyond that. Back in March of 2017, when then-Secretary of State Rex Tillerson visited Turkey, Foreign Minister Mevlut Cavusoglu reiterated Erdogan’s demand that Gulen be handed over to Turkish authorities and while standing next to Tillerson at a press conference, accused Bharara (who had been fired by Trump just two weeks earlier) of being a Gulen sympathizer.

Just a month before that March meeting between Tillerson and Cavusoglu, Erdogan met with Rudy Giuliani and Michael Mukasey, who represented Reza Zarrab, the trader with Erdogan ties implicated in an oil-for-gold scheme that involved the circumvention of U.S. sanctions on Iran. Zarrab was prosecuted last year, much to the chagrin of Erdogan.

Giuliani called Bharara on February 24, 2017, and told him about his planned trip to Turkey. On that trip, Giuliani attempted to secure some kind of concessions from Erdogan in exchange for the release of Zarrab. Bharara was fired by Trump just 15 days later.

In any event, Pastor Brunson is just the latest pawn in Erdogan’s one-sided chess match with Gulen, where “checkmate” would be securing Gulen’s extradition. “The Turkish authorities have suggested handing Mr. Brunson over to the United States in exchange for Mr. Gulen’s extradition to Turkey to face charges in the coup attempt”, The New York Times notes.

Unless Washington agrees to a Brunson-for-Gulen exchange, the North Carolina preacher faces something like three decades in a Turkish prison if he’s found guilty of conspiring with Gulen, which of course he will be.

The sheer absurdity inherent in all of this is indicative of the way Erdogan generally does things, and by “things” I mean all things, up to and including how he manages the Turkish economy. He is the very definition of irrational – the picture of belligerence.

So when the Turkish lira was plunging earlier this year and Erdogan showed up on Bloomberg Television to calmly explain to a bewildered TV anchor how he planned to commandeer monetary policy following the June 24 election, there was exactly no reason to doubt him and every reason to trust that once he consolidated power in a new executive presidency (a position he made up), that he would indeed move to enshrine his “unorthodox” views on interest rates into official policy.

Following that interview, the Turkish central bank was allowed to take a series of steps to shore up the currency in the interest of political expediency, but the market seemed reluctant to accept the notion that that’s all it was – political expediency. Erdogan has no patience for higher interest rates (which he calls “the mother and father of all evil”) and even less patience for what he claims is an international conspiracy to undermine the Turkish economy which, according to him, is the envy of the rest of the world.

Still, the market held out hope. That faith would prove to be misplaced when, on July 9, Erdogan installed his son-in-law as economic czar leaving no room for Mehmet Simsek, who the market viewed as the last bastion of sanity.

Despite the fact that Erdogan’s move to make economic policy officially a family affair clearly indicated that the central bank would come under immense pressure to avoid raising rates and despite the fact that he (quite literally) amended the central bank’s articles of association in order to strengthen his own influence, traders and analysts were still betting on a rate hike at this week’s meeting.

Well, those traders and analysts would be disappointed because sure enough, the central bank kept rates on hold despite the worsening inflation outlook and despite the egregious fundamentals underlying the Turkish economy.

Now, on top of everything, you can add the threat of sanctions from the Trump administration to the mix. Pence’s threat wasn’t well received by markets and the lira legged sharply lower.

Trump chimed in later, demanding Brunson’s release and employing some of his signature hyperbole to drive the point home:

The United States will impose large sanctions on Turkey for their long time detainment of Pastor Andrew Brunson, a great Christian, family man and wonderful human being. He is suffering greatly. This innocent man of faith should be released immediately!

— Donald J. Trump (@realDonaldTrump) July 26, 2018

That prompted a response from Turkish Foreign Minister Mevlut Cavusoglu, who insists that Ankara won’t be “tolerating” any threats from Trump or anyone else for that matter.

Noone dictates Turkey. We will never tolerate threats from anybody. Rule of law is for everyone; no exception.

— Mevlüt Çavu?o?lu (@MevlutCavusoglu) July 26, 2018

The ultimate irony there is that both in Turkey and the United States, it has never been less true that the “rule of law” apples to “everyone” with “no exceptions.” There are two notable “exceptions”: Trump, in the U.S., and Erdogan, in Turkey.

For traders and, perhaps more importantly, for asset managers, this is just further evidence that Turkish assets are anything but attractive following last month’s election. While EM fund managers will claim to understand all of this, it still feels like there’s a generalized unwillingness to accept the reality of this situation.

Accepting idiosyncratic, country-specific risk is part and parcel of investing in emerging markets, but this has gone well beyond that. This is Erdogan–specific risk and he has shown time and again that betting on him to abruptly step out of character and demonstrate some semblance of rationality is fool’s errand.