Summary
Sharp sell-offs in Turkey fans fears that dollar stress is coming to a head, as an emerging market currency rout gathers pace.
Turkey avoids the inevitable
The lira’s plunge has barely decelerated despite Turkey’s finance minister flagging an action plan earlier, that is now out. It stops short of raising interest rates. Yet only an aggressive and immediate rate hike has any hope of stabilizing Turkish markets. Therefore, the feeding frenzy against the lira and sell off of other Turkish assets is becoming entrenched. The latest comments by President Tayyip Erdogan signal no change of heart in his stance as an “enemy of interest rates”. After he grabbed more monetary powers and ended central bank independence, the likelihood that CBRT policymakers will (or can) persuade the president to see sense before Turkey experiences critical economic pain is distant. For these reasons, the sea of red confronting investors at the start of the week is unlikely to ebb quickly.
Unknowns get sold
Europe’s known ties to Turkish banks together with uncertainty over exact exposures means Eurozone banks are still the main channel by which Turkish financial stress is transmitted to EU markets and beyond. Key protagonists are Spain’s BBVA (MC:BBVA), France’s BNP Paribas (PA:BNPP) and Italy’s UniCredit. Protestations that their exposure amounts to low single-digit basis points apiece in terms of regulatory capital buffers aren’t getting much traction. Dark clouds over markets even before Turkey became a new pain point meant investors were already shunning shares with higher perceived risk of contagion risk in the event of an EM-blow-up. At last look, the French bank’s stock was down around 1%, against UniCredit’s 4.6% fall and BBVA’s 4% slide. As per last week these declines are progressively worsening throughout the session.
Moderate exposure writ large
In any case, the three European banks thought to face the widest exposure are among those with lowest levels of Tier 1 capital as a ratio of risk-weighted capital, the buffer regulators demand banks hold as protection against economic shocks. At the end of last year, BNP Paribas had the highest amongst the three, with 12.6%, compared to 15.4% on average for Eurozone banks. The perceived relative weakness of the trio is another reason that selling of the sector—the biggest burden on European indices for a fourth-consecutive session—is unlikely to relent on Monday. In turn, European indices will also remain becalmed. Major lenders are likely, this week, to provide more detailed assessments of their exposure to Turkish assets and other regions with challenged markets. Pressure on certain bank stocks could begin to ease afterwards.
Turkey, Russia lead official EM inaction
Unsurprisingly, speculation about intervention, and other potential steps by global financial officials, is rife. As for Turkey’s central bank, it announced late on Monday morning that it aimed to meet banks' lira liquidity needs with an overnight rate of 19.25% whilst cancelling a regular bond buyback auction. This was interpreted by some as a precursor to tightening. However, the threshold of credibility seems highest for Turkish policymakers amongst pivotal emerging markets. Its officials continue to make defiant comments that are abstracted from current realities, urging in fact, that these should be ignored. The clear-eyed resolve required to instigate sharply higher rates and park them at elevated levels to curtail attacks against the lira appears lacking. For Russia, whose rouble is also among the hardest hit EM currencies, the certainty of inaction is greater, even after Monday’s fresh 14-month low. Moscow has signalled it has no appetite to spend any of its $458bn reserve on propping up the rouble after the failure of a similar exercise in 2014.
Euro capped, sterling risks rise
Pressure from Turkey and Russia should keep pressure on European assets particularly acute and the euro stuck below $1.14, at least before Tuesday’s Eurozone growth readings. For similar reasons, at least ahead of UK employment data on the same morning, sterling has little hope of breaking away from near 13-month lows with the dollar underpinned. Two days of UK-EU trade talks are scheduled to begin on Thursday. A major breakthrough would be a major surprise with key political monetary figures keen to point out that Britain may be underestimating the chances of crashing out with no deal. The risk of a volatile and alarming overshoot by sterling to the downside thereby seems heightened this week, given that frayed sentiment and elevated nerves abound.
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