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‘Don’t Be Afraid At All’: In Turkey, Desperation As Currency Crisis Spirals

"Don’t be afraid at all, it will all pass."

Laughable.

That’s the only adjective I can conjure when it comes to describing the ongoing dispute between Washington and Ankara over detained North Carolina Pastor Andrew Craig Brunson and the effect this seemingly intractable situation is having when it comes to making a bad situation worse for the Turkish lira, which slid to a fresh all-time low against the dollar on Thursday.

I’ve spent an inordinate amount of time documenting this over the past several weeks, although upon reflection, I’m not sure “inordinate” is the right word. This is important. Irrespective of the impact Turkey “should” have (mechanically speaking) on emerging market assets as a group, the collapse of the currency and the country’s plunge into one-man rule is a curse on risk sentiment – a veritable albatross around the neck of a market that’s already laboring under a veritable laundry list of geopolitical concerns.

USDTRY

(Major events impacting Turkish lira since March)

On Tuesday, I endeavored to recap how we got to where we are in Turkey in a piece called “Turkey In Crisis: A Narrative History And An Annotated Chart“. That’s an extremely handy reference guide for anyone interested in understanding the evolution of the political backdrop in Turkey in 2018 and how Erdogan’s power grab has served to irreparably harm market sentiment. As far as the Brunson debacle goes, there’s a brief history of that available in “As Trump, Pence Threaten Turkey With Sanctions, It’s Time For Markets To Accept The Reality Of Erdogan“.

Simply put, what’s happening to Turkey represents the collision of authoritarianism and gross mismanagement of an economy, two things that have a tendency to intersect historically speaking.

With Erdogan, the situation is made immeasurably worse by his obsession with  Fethullah Gulen and his steadfast refusal to concede that his version of economics (in which higher rates beget high inflation and currency weakness) is just flat out wrong. He couches every domestic political problem in terms of Gulen and/or the PKK and when it comes to the currency and inflation, he doesn’t just rail against higher rates, he talks about interest rates as though they are sentient beings capable of having a sense of purpose.

Things took a further turn for the ridiculous on Wednesday when a delegation dispatched to Washington ostensibly to mend ties, refused to negotiate for Brunson and instead used the meeting to talk about Halkbank, which has been living under the cloud of the Reza Zarrab drama for months on end. According to reports out last week, there was a deal in place for Brunson 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. As part of the deal for Brunson, Halkbank would get off with a “lenient fine” for its role in the oil-for-gold scheme.

Long story short, that fell apart. So now, the market thinks maybe the sanctions leveled against Turkey’s Minister of Justice Abdulhamit Gul and Minister of Interior Suleyman Soylu might presage something more consequential like, say, a horrific fine for Halkbank, hence yields on the bank’s June 2020 dollar debt exploding higher amid the Brunson dispute.

Halkbank

(Yields on Halkbank’s June 2020 USD bonds surge, Bloomberg)

According to multiple media reports, Turkey refused to discuss Brunson on Wednesday and the U.S. refused to discuss Halkbank and/or Atilla unless the Turkish delegation discussed Brunson. You can see how that’s a dead end dynamic.

Of course this all comes back to Fethullah Gulen. If the U.S. would agree to extradite Gulen, Erdogan would happily release Brunson and would likely be willing to make all manner of other concessions. But that’s not going to happen and so, the lira plunged anew on Thursday and is currently trading around 5.46.

USDTRY

(New record lows for the lira, which has plunged dramatically since the central bank surprised markets by eschewing an expected rate hike late last month)

Meanwhile, the Turkish central bank is hamstrung in its capacity to arrest the slide in the currency. Policymakers were already under immense political pressure from Erdogan prior to the election, but once he put his son-in-law Berat Albayrak in charge of the economy and amended the central bank’s articles of association last month, it was clear that the scope for emergency, “shock and awe” type hikes was severely limited.

Well on Thursday, Albayrak is out with a “cunning plan” (to quote the notoriously deadpan Katie Martin). Specifically, Albayrak says he’s all set to announce a “new economic model”. The finance ministry mailed a statement around to anybody who cares on Thursday, the details of which call for a 2018 budget gap below 2% of GDP and a current account deficit that “stabilizes” at around 4% of GDP. Growth in 2019 is projected to be between 3% and 4%. The country’s banks and non-financial corporates “face no FX or liquidity risk”, the ministry insists.

Here’s a bit of useful color from a Barclays note out a few months ago:

Thus far, there have not been any signs of stress in debt rollovers (Figure 4 and Figure 5), suggesting that Turkey is likely facing re-pricing risk (ie, a debt rollover at higher interest rates) rather than roll-over risk. However, the distinction between mere re-pricing and true roll-over risk is fluid. Still, the USD12bn in monthly external refinancing needs (assuming a full rollover of trade credit and non-resident deposits) leaves Turkey quite vulnerable to sudden shifts in capital flows, in our view.

TurkeyDifferent2

The issue here is that no matter what he says, Albayrak is going to have a hard time convincing markets. Remember, it’s not that he’s completely bereft when it comes to the type of training you might need to run an economy. Rather, it’s that there are only a handful of people on the entire planet with the guts to tell Erdogan “no”, and you’ve got to believe that his son-in-law isn’t one of those people. Here’s a hilarious quote to that effect from Nigel Rendell, a senior analyst at Medley Global Advisors, who spoke to Bloomberg via e-mail for a piece last month:

Yes, he’s got an MBA from a U.S. university and he’s been a CEO, but is he really going to stand up to his father-in-law? Would he be prepared to argue that interest rates should be significantly higher and economic policy much tighter? If we look back and ask who’s stood up to Erdogan and come off better, it’s a short list. In fact, it’s a list with no names.

Actually, if you made a list of people who have stood up to Erdogan and then tasked a super computer to cross-check that list against a list of people who are both alive and not in prison, the only name you’d come up with is Fethullah Gulen, who Erdogan will eventually get his hands on even if Michael Flynn has to kidnap him in the middle of the night (allegedly).

That’s the problem here and everyone knows it.

“While a deterioration in relations with the US is clearly a negative, the real underlying issue that drives our cautious view on the currency is more about unsustainable levels of internal and external balance, and the absence of policy credibility to address this challenge”, Goldman wrote earlier this week, adding that while the lira is cheap and the carry is tempting, “without policy credibility there is a risk of further disorderly moves in Turkish assets if the external environment deteriorates or if concerns around bank balance-sheets grow.” “Policy credibility” is just a euphemism for “Erdogan is crazy”.

Here’s what Credit Suisse said on Wednesday on the way to explaining why their “general bias remains to fade rallies in the lira”:

Our rationale is that the main issues that weigh on the lira at this point, beyond the tensions with the US, are questionable policies and the risk of a “hard landing”. These factors are not going to be resolved even if the tensions with the US cool down. Furthermore, at this point, it seems to us that the possibility of acceleration in the pace of the depreciation of the lira is probably higher than the possibility that a meaningful rally will be sustainable. The reason behind this thinking is that the risk of rush for dollars by local households and corporates has increased given the possibility that inaction by the central bank will eventually push inflation expectations substantially higher.

Right. And as noted last weekend, Erdogan is now imploring citizens to ignore the temptation to hoard dollars. Here’s what he said late last week:

Bring out the dollars, the euros and the gold. Turn them into liras. Show your local and national resistance against the entire world.

On Thursday, Milliyet quoted Erdogan as follows:

Everything will get better in a reasonable time. The markets will settle down. Don’t be afraid at all, it will all pass.

I’m not sure that’s very reassuring. Credit Suisse went on to say the following in the same note cited above:

It seems to us that in order to break the vicious cycle for the lira in a structural way, markets need to regain confidence in Turkey’s government and the central bank ability and willingness to tackle rising inflation and rising funding rates for the private sector. For example, markets could regain confidence in case the government signals that it intends to engineer a credible plan to assist banks and corporates to roll over their external debt. However, based the signals from the Turkish government and the central bank since the 24 June elections our sense is that these issues are not going to be addresses in a structural manner over the short run.

Asked by a Twitter user what Turkey can do to break this cycle, Bluebay’s Tim Ash said this on Wednesday:

Sort out the problems with the US, and get an IMF deal.

I don’t know about anyone else, but it seems entirely unlikely to me that Erdogan would be willing to go the rescue route less than two months after consolidating power. As far as sorting out the problems with the U.S., that may well happen but paradoxically, only because Erdogan might see a resolution to the diplomatic spat as preferable to rate hikes when it comes to arresting the slide in the lira.

I’ll give the last word on this one to Tracy:

I see Turkey is the only one *really* committed to celebrating the 5-year anniversary of the ‘Fragile Five’ term.

FragileFive

The original, for reference…

MorganStanleyFragileFiveOrig

 

 

 

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