On Wednesday, the diplomatic row between Washington and Ankara took another turn for the worst when the U.S. imposed sanctions on Turkey’s Minister of Justice Abdulhamit Gul and Minister of Interior Suleyman Soylu. The ministers, Washington says, “played leading roles in the organizations responsible for the arrest and detention of Pastor Andrew Brunson.”
Brunson is just the latest pawn in the ongoing chess match between Erdogan and the U.S. Erdogan is determined, come hell or high sanctions, to secure the extradition of Pennsylvania-based cleric Fethullah Gulen, who Ankara insists is engaged in a perpetual effort to undermine the Turkish government.
The Brunson dispute is the latest evidence to support the contention that Erdogan, emboldened by his successful effort to consolidate power in a new executive presidency, will become increasingly obstinate over time. That bodes poorly for Turkish assets including and especially the beleaguered lira, which has been in free fall this year amid soaring inflation and signs that the central bank is constrained by politics when it comes to taking the necessary steps to arrest the currency’s slide.
In the course of documenting the Brunson story last week, I suggested it’s time for emerging market fund managers to accept reality and abandon Turkey up to and until there are convincing signs that Erdogan is prepared to govern in a rational manner.
Predictably, things got worse on Thursday, as the lira slid to fresh all-time lows above 5.09. This is an absolutely horrific two-day chart:
Asked whether Turkey was in the midst of a currency crisis on Thursday morning while speaking to Bloomberg Television, JPMorgan’s Marko Kolanovic said “it is”, but reiterated his recent call for an emerging market equity rally under certain conditions.
The Turkish Foreign Ministry is furious at the sanctions push. Here’s the statement:
There is no doubt that the decision, which disrespectfully meddles in our judicial system, violates the essence of our relations and will seriously damage the constructive efforts made to resolve problems between the two countries. An equivalent response to this aggressive attitude will be given without delay.
Another thing that happened “without delay” was a further spike in 10Y yields, which rose another 60bps on Thursday, to a new record high of 19.19%.
(Bloomberg)
For their part, Turkish stocks dove with Halkbank declining some 5% on the day. According to reports out on Thursday, there was a deal in place between the U.S. and Turkey that would have called for Mehmet Hakan Atilla to be shipped back to Turkey from a U.S. jail. Atilla was convicted earlier this year for his role in a plot to avoid American sanctions on Iran and was sentenced to 32 months in prison in May. The case, profiled in these pages in great detail, grabbed national headlines when Erdogan was implicated by gold trader Reza Zarrab.
As part of the deal for Brunson, Halkbank — which was at the center of the U.S. court case — would get off with a “lenient fine” for its role in the oil-for-gold scheme. With that apparently off the table, the shares are under pressure.
Earlier this week, prior to the announcement of sanctions, shorts added to bets against the bank, with short interest climbing to 6.36% – that’s the highest since at least 2007.
Just to reiterate, the timing here is awful. Turkey relies on external financing and U.S. sanctions don’t do much in the way of inspiring confidence. The lira slide exacerbates that dynamic. Or at least that’s the way it looks from where I’m sitting.
Erdogan’s son-in-law (who was installed to head the economy early last month, much to the chagrin of market participants), said on Thursday that the country was seeking “alternative sources” of funding.
“Negotiations for short and medium term, different sources of foreign financing, are ongoing in a positive way,” Albayrak told Bloomberg, in an emailed statement, before calling the sanctions unacceptable. He also said that “attacks” on his father-in-law’s economy will be short-lived and any “speculative attempts” to drive the currency lower will be foiled.
With that in mind, think back to what I said here on Wednesday about how Erdogan would invariably spin this:
The worse it gets for the currency, the more scope there is for FX pass-through inflation and if last week’s CBT meeting was any indication, you cannot expect that Erdogan will allow the central bank to do what’s necessary to stem the lira’s decline.
In fact, it’s more likely he’ll do the opposite. That is, if U.S. sanctions were to pile still more pressure on the currency, it would give him more ammunition when it comes to his contention that Turkey’s problems are the fault of nefarious foreigners.
There you go.
As for what comes next, I guess it’s best to just employ a Trumpism: “We’ll see what happens.”
