The Turkish Lira is in the grip of one of the worst routs as the currency slumped for the fourth day to hit a new record low. The selloff is spreading to other emerging market currencies after Turkey’s President Recep Tayyip Erdogan shows no signs of backing down in the escalating standoff with the United States.
Figure 1: Intraday trade showing the lira continues to weaken despite central bank liquidity boost.
The decline in the lira is multifaceted caused by the country’s weak external position in terms of big deficits, inadequate currency reserves, double-digit inflation and a challenging political environment through newly imposed U.S. sanctions on Turkish steel and aluminium. At the time of writing, the lira hit a new record low of 7.2362 against dollar before finding some support. The lira has fallen 40% this year eclipsing its previous 36% slump back at the height of the 2008-2009 global financial crisis.
Figure 2: Tracking the lira to new record lows.
Turkey’s economic problems is a victim of the government’s economic agenda to boost economic growth at all costs encouraging Turkish companies to load themselves with hundreds of billions of dollars in foreign currency debt which fuelled consumption and spending and resulted in an ‘overheated’ economy with inflation running at 16% (exceeding the 5% central bank target) along with large deficits. The central bank could have increased interest rates to stem the large increases in prices as higher rates would have attracted foreign investors who would have bought Turkish assets, which would have supported the currency, making imports cheaper and decreasing the burden in paying back foreign debt.
However, President Erdogan prefers lower interest rates and has influenced the country’s central bank to maintain this which has undermined investor confidence resulting in the large falls in the lira that we have seen.
In addition to economic problems, the U.S. has imposed tariffs on Turkish aluminium and steel exports in retaliation in its refusal to release U.S. citizens and employees imprisoned since the attempted coup attempt against President Erdogan back in 2016. Both countries are unlikely to back down anytime soon with President Trump increasing tariffs by a further 20% on August 10th.
Figure 3: Point at which the lira sank after U.S. sanctions imposed on August 1.
Despite the central bank taking steps to support the lira by allowing commercial lenders to hold more funds and gold thereby improving liquidity in the banking system, we see more market turmoil in the coming week as markets continue to lose faith. In our opinion, an immediate interest rate hike of between 3.5-to-4% will not be sufficient to curb the sell-off as the central bank needs to be seen acting independent of government in order to restore credibility.
Turkey’s financial woes are spreading to other countries with exposure to Turkey along with emerging market currencies. HXL continues to sell the euro as Spanish, Italian and French banks are the most exposed to Turkish foreign currency debt. Turkish borrowers owe Spanish banks USD$83 billion, French banks USD$38.4 billion and Italian banks USD$17 billion. Spanish bank BBVA and Italy’s Unicredit are the most exposed as they part own Turkish banks. At the time of writing, the euro has fallen below 1.140 against the U.S. dollar. We don’t see this as a buying opportunity at the moment as continued volatility emanating out of Turkey may result in near-term euro weakness with the possibility of the currency overshooting 1.12. Longer-term, if Eurozone economic activity turns more positive, Turkey’s economic problems will not be large enough to reverse ECB monetary policy.
Along with the euro, we have sold the Swiss Franc, Australian Dollar and the Korean Won while buying the JPY, USD and U.S. Treasuries. We have not bought into Gold as demand remains subdued.
Figure 4: Turkish Lira is the world’s worst performing currency year-to-date.
Emerging Market Contagion
Turkey’s woes has spread to emerging market assets. Following the general market ‘knee-jerk’ reaction, we have sold the Indonesian Rupiah, South African Rand, Mexican Peso, Russian Ruble and Argentine Peso as these countries have small foreign reserves and large external debt.
Figure 5: How the lira affected other emerging market currencies (intraday trade 13/08/2018)
South African Rand
Separate to emerging market concerns, HXL continues to sell the Rand based on continued uncertainty on government policies relating to land and mining. Although the drivers of the lira’s decline are specific to Turkey, in the short-term, we see the Rand to continue to be vulnerable as it will continue to be influenced by the movements in the Turkish lira. Until the lira stabilises, we believe we will continue to see weakness across all emerging market currencies.
Figure 6: South African Rand hits two-year low.
HXL continues to advise clients to sell long positions in the ruble as further U.S. sanctions will likely hit the Russian economy much harder than the initial sanctions which should see the ruble weaken even further. We see potential new sanctions by the U.S. targeting Russian state-controlled banks by freezing their dollar transactions, restrictions on imports and exports and barring U.S. banks from making loans to the Russian government having a destabilising effect on the stockmarket and the economy. As Russia continues to become more isolated, capital outflows will accelerate, lowering the value of ruble-denominated assets leading to further falls in the currency. As a consequence it is too much of a risk in holding rouble denominated assets.
Figure 7: Ruble continues to be pummelled on the likelihood of further U.S. sanctions.
Luxury Now Cheaper in Turkey
Turkey is now the cheapest place in the world for shopping as the slide in the lira has suddenly made luxury goods cheaper to buy. Arab and Asian visitors are waiting in lines for up to 30 minutes at stores like Chanel, Hermes and Louis Vuitton to snap up bargains. For example, the ‘Classic Chanel Camera Case Bag’ retails for TRY 18,500 lira (US$2,877) à 25% less than the same bag listed on Chanel’s Europe online site retailing currently at US$3,700.
Figure 8: Chanel Camera Case bag is now 25% cheaper in Turkey.
Overall, events in Turkey will have a short-term impact on assets outside the country. For traders, we will continue to sell lira until the Turkish central bank acts independently of government to increase interest rates, policy makers start implementing fiscal tightening and the U.S ends sanctions. For all of these to materialise, there is only one person that can make this happen. The longer this situation continues, we will also continue to sell other emerging market currencies following general sentiment and move into safe haven assets such as the U.S. dollar, Japanese yen and U.S. Treasuries.
For longer-term investors that have a well-diversified portfolio, the events in Turkey will not have a long-lasting impact.