Recently, investors have been focused on the country’s political and economic crisis, especially given the plunging Turkish lira.
The stage was set through external borrowing (and as we say, debt doesn’t matter until it does). Tariffs have been a concern, but were not the main issue. However, the White House doubled tariffs on Turkey last week (because the weaker currency had offset the earlier tariff increase). The currency has weakened further, partly on monetary policy missteps (Erdogan has pressured the central bank to keep interest rates low – while a currency crisis normally requires higher interest rates to stem capital outflows).
By itself, Turkey’s economy is not large relative to the global economy. However, its military is the second largest in NATO and Erdogan is seeking a closer alliance with Russia.
The bigger concern is contagion. There may be parallels with the 1997 Asian financial crisis (which rolled from country to country). Fed rate increases have increased tensions on emerging economies (many of which have borrowed in U.S. dollars and will pay more to roll over that debt) – and there’s a tendency for investors to lump emerging economies together (whether or not there are problems). The extent of the damage is hard to forecast, but the late MIT economist Rudi Dornbusch said that currency crises take longer coming than you expect, but then happen much faster than you would have thought.
For U.S. financial markets, the strong dollar will restrain share prices (as overseas earnings, translated to dollars, will be lower than they would have been otherwise). The flight to safety should keep the dollar strong and put downward pressure on yields of long-term Treasuries (lower bond yields or preventing yields from rising). At this point, the Fed remains on track for a September 26 rate hike and the market odds of a mid-December move are a little more than 50/50 – but that can change if conditions warrant.
– Scott Brown, Ph.D., Chief Economist, Equity Research
Mention of turkey in the summer is typically centred around a summer holiday or some unseasonal longing for a Christmas meal. In the last week or so, however, mentions of Turkey have been centred on the country’s political and economic crisis, captured by the plunging Turkish lira.
Turkey has plenty of challenges with a rising budget deficit and a sticky inflation rate, but it has not helped itself by having a central bank which appears deeply influenced by politics. This is a shame because the country sits in a strategically good location and has a youthful and well-educated workforce. So whilst the outlook today looks grim, the country retains an ability to bounce back over time, assisted by some combination of deeper strategic backing from the European Union, Russia, and China. Shorter term, however, this is another signal that the geopolitical backdrop today is not straightforward.
Worsening U.S.-Turkish relations over recent weeks (culminating in a doubling of steel/aluminum tariffs by the U.S.) reflects the world’s biggest economy getting their elbows out on multiple matters pertaining to financial markets, supplemented by the impact of a higher dollar and a differentiated higher interest rate cycle by the Federal Reserve. If you are looking for reasons to be cautious then look no further. The better news is that the post-midterm election period probably does not offer so much … flexibility for U.S. external policy and rhetoric. And with this comes the scope for a lower dollar and more general calm and balance in the emerging markets. In my opinion, it is time for President Trump to strike a few deals and for investors to buy emerging market and European stocks.
– Chris Bailey, European Strategist, Raymond James Euro Equities*
*Affiliate of Raymond James & Associates and Raymond James Financial Services
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