I’m calling out to industrialists, do not attack banks to buy FX. It is industrialists’ duty too to keep this nation on its feet. Otherwise we will set into motion our plan B and C.
That’s from one of three speeches Recep Tayyip Erdogan delivered on Sunday in the hours ahead of the market open in Asia and needless to say, exactly nothing the Turkish President said over the weekend will quell investor fears.
Early indications suggested there’s more pain ahead – USDTRY was quoted above 7.23. Last week, Wells Fargo suggested the lira could see 8.00 in the absence of … I don’t know … in the absence of something that isn’t likely to happen.
Wells: lira going to 8…. pic.twitter.com/RVO2SXJMLG
— Heisenberg Report (@heisenbergrpt) August 10, 2018
The lira tumbled as much as 17% on Friday as concerns about central bank independence and the worst diplomatic spat between Washington and Ankara in recent memory finally culminated in the collapse of Turkey’s currency. Donald Trump’s decision to double metals tariffs applicable to Turkey was just gas on the fire.
(Annotating Friday’s collapse in the lira)
Erdogan remained defiant, lashing out at the U.S. on Saturday and doubling down on Sunday in Trabzon, where he variously ruled out an IMF program and pledged not to raise rates to combat inflation.
“Further escalation [in diplomatic tensions] would add considerable downside risks but the sell-off in the TRY reflects more fundamental factors, including the unresponsiveness of the central bank to rampant inflation, an elevated current account deficit, and large FX liabilities and external financing needs”, Barclays wrote over the weekend, adding that “so far, the central bank has been silent, while the finance ministry has not delivered any clues for a potential stabilization plan.”
(Barclays)
Given the risk off sentiment that accompanied the lira’s slide to close the week, markets will be watching closely for signs of contagion. One of the catalysts for Friday’s rout in the currency was a Financial Times story that suggested the ECB is concerned about the exposure of BBVA, UniCredit and BNP Paribas to Turkey’s ongoing meltdown. That pushed the euro to a one-year low.
In addition to worries of contagion to European banks, the turmoil in Turkey is a stark reminder to markets of the dangers inherent in reckless fiscal policy (ahem – Italy). Here’s BNP’s take:
EURUSD has traded through 1.15, a level which has held since July 2017. We remain tactically bearish, maintaining our 1.14 target, with risks to the downside. A pre-requisite for a meaningful rebound in EURUSD is a de-escalation of trade tensions. However, we think this is unlikely before the US mid-term elections in November. Further, concerns about Italy are likely to remain elevated ahead of the budget presentation due in September. Therefore, even if EURUSD were to stabilise in a scenario where pressure on the TRY begins to alleviate, we would not anticipate a quick material rebound in August.
Do note that iTraxx SubFin spreads widened by ~16bps on Friday – that looks like the biggest single-day widening since May, when the BTP market was imploding.
Obviously, the question for emerging markets is whether Turkey is an “isolated” incident. Last week, analysts were at pains to explain that the fundamentals are generally sound, although that’s been a highly contentious debate all year long amid the dollar rally and the Powell Fed’s persistent hawkishness. The MSCI EM FX index had its worst day since May of 2017 to close the week.
“Expect TRY to continue jumping for the Asia day as screen ‘prices’ get updated via wide untradeable quotes rather than real dealing”, Bloomberg’s Mark Cudmore cautioned on Sunday evening, before going on to warn that “unfortunately, traders will feel obliged to react to this price guidance” and that means you should “expect similar moves in other volatile high-yielders such as MXN, RUB and BRL.”
In addition to an unapologetic Fed that’s essentially been pigeonholed by Donald Trump’s aggressive fiscal policies, EM sentiment is vulnerable to the U.S. administration’s growing reliance on unilateral sanctions and tariffs. On Saturday, we implored you not to forget about Russia. While the collapse of the lira grabbed the spotlight on Friday, it’s important to remember that the ruble is now staring down the prospect of sanctions on sovereign debt thanks to bipartisan legislation introduced by Lindsey Graham and Democratic Senator Bob Menendez earlier this month. Russian media published the full text of that bill on Wednesday and hours later, the State Department announced separate sanctions on Russia in connection with the Skripal case. Any further news there could be destabilizing.
“The latest leg of RUB weakness came after the US State department announced restrictions on Russian imports of goods and technology beginning on August 22, with the possibility of a second wave of sanctions coming 90 days later”, Barclays wrote on Sunday, on the way to warning that “the bipartisan bill introduced in Congress brings considerable risks to Russian local assets in case measures affecting new sovereign debt are implemented.”
Given heightened concerns around EM, it will be interesting to see what comes out of Bank Indonesia’s meeting this week. The current-account deficit widened to 3% of GDP in Q2, versus 2.2% in Q1, the bank said on Friday. The central bank has tried desperately to stay ahead of the game this year, but the rupiah remains under pressure.
It’s also worth paying attention to the ongoing diplomatic dispute between Canada and Saudi Arabia. Some U.S. officials believe Trump’s contentious relationship with Justin Trudeau is in part responsible for Saudi Crown Prince Mohammad bin Salman’s aggressive move to cut diplomatic and trade ties with Canada. Canadian officials angered Riyadh by expressing alarm over the arrest of Samar Badawi, the sister of Raif Badawi, a jailed dissident whose plight grabbed international headlines in 2015 and whose wife lives in Canada (full story on that here). On Friday evening, Trump suggested he’s willing to make a trade deal with Mexico without Canada at the table.
In the U.S., we’ll get retail sales this week. On Friday, the latest CPI numbers showed core inflation rising at the fastest pace since 2008, seemingly strengthening the case for an expected September hike and thereby reinforcing the case for a stronger dollar.
Of course there’s been no progress to speak of in the trade dispute between Washington and Beijing. If anything, the situation has deteriorated meaningfully of late. “Stalled conversations with China have brought no positive news on the Sino-American trade war front”, Barclays lamented on Sunday. Those interested in all the latest on that story are encouraged to check out Friday’s “Who’s Really ‘Winning’ The Trade War? The Truth Behind The Rhetoric” if for no other reason than we spent an inordinate amount of time writing it for you.
It’s probably best to just leave you with a quote from a May note by Istanbul-based broker Alnus Yatirim who, following Erdogan’s deadpan Bloomberg TV interview, said this in a note to clients:
God help Turkey.
Hopefully sanctions on Russia will include asbestos.