August 14, 2018

Observing the freefall in the Turkish lira from 30 minutes away on the Bulgarian side of Turkey – where I am visiting friends and family – I must say that I am not surprised. After years of rampant dollar borrowing, running large current account deficits (due to the lack of domestic oil production), as well as an autocratic President who thinks that high interest rates produce inflation and meddles in the economy in ways that are guaranteed to backfire (as they are doing at the moment), the lira is now in freefall.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary

Such dramatic weakening is rubbing off on other emerging-market currencies with similar macroeconomic issues, like the Argentine peso, and this is spilling over into emerging markets’ stocks and bonds. For more, see my May 30 Marketwatch article, “The carnage in emerging markets stocks is just beginning,” where I identified Turkey, Argentina, and China as trouble spots.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The JP Morgan Emerging Markets Currency Index has broken major support levels and is much lower than its January 2016 level, when the Chinese stock market re-crashed and the S&P 500 had its weakest January ever, based on worries of a hard economic landing in China. In such currency freefall situations, there needs to be decisive action by Turkey’s central bank (by hiking interest rates) and by their economics team, which in Turkey is headed by Erdogan’s son-in-law, Berat Albayrak (pictured below).

If marrying into Erdogan’s family is a qualification for a ministerial post, one has to wonder as to the level of expertise that this person possesses to deal with a currency crisis.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Furthermore, amidst the lira slide, President Erdogan called none other than Russian President Vladimir Putin to discuss the economic situation. The Russians famously stemmed a slide in the ruble in late 2015 by hiking interest rates rather aggressively. There has been a belated rate hike by the Turkish central bank in this case, but it can only be characterized as too little too late. How can a central bank chief do his job when an authoritarian president is breathing down his neck saying, “High interest rates cause inflation”?

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

As of Friday’s close, Turkish 10-year government bonds yield 18.85% and who knows what they will yield next week. This reeks of wholesale dumping of bonds by investors who previously chased yields. The problem with chasing 19% bond yields is that if the lira decline is not arrested, the surging inflation caused by the collapsing lira wipes out any coupon payments, even over a 10-year period. Plus, bond investors surely think that capital controls may be forthcoming, so government bonds are in a freefall.

In the middle of all this mess, which started with the Federal Reserve upping the rate of quantitative tightening in 2018, exacerbated by the recent Trump steel and aluminum tariffs, President Erdogan decided to invoke the name of God: “…they have their dollars, we have our people, our God. We are working hard. Look at what we were 16 years ago and look at us now,” he said last week in a speech.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Based on 20 years in the trenches in the fascinating world of finance, I can tell you that the Good Lord has very little to do with sound macroeconomic policies. There are pretty-well established procedures of what a central bank does in order to fight currency weakness and what economic policies the government runs in order to assure a balanced current account and overall sound macroeconomic foundation. There are some very serious issues on both the monetary and fiscal policy front in Turkey, exacerbated by the new Trump tariffs, that suggest to me that divine intervention will likely not be forthcoming.

Safe Havens for the Turkish Mess

In the U.S., one safe haven would be Treasury bonds. In the eurozone, it would be the German 10-year bunds or the still negative-yielding 2-year bundesschatzanweisungen, dubbed schatze notes to avoid tongue injuries. The bunds closed last week at 0.31% while the schatze notes closed at -0.61% (last year, the schatze yielded as low as -0.95%).

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

It looks like Erdogan is digging in his heels as to the Trump administration confrontation while not being proactive as to the Turkish lira crisis. This means the whole mess is spilling into the other emerging markets – and that’s even before the major confrontation with China kicks in around September 5, after most Chinese tariff packages begin to go into effect.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The only response to this mess is for the dollar to keep surging, which ironically creates a negative feedback loop, making the Turkish (and other emerging markets) situation more difficult to contain. We came to within 3.5 points from 100 last week on the U.S. Dollar Index, and I would not be surprised if we cross that centennial mark on the U.S. Dollar Index rather expeditiously.

About The Author

Ivan Martchev
INVESTMENT STRATEGIST

Ivan Martchev is an investment strategist with Navellier.  Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. *All content of “Global Mail” represents the opinion of Ivan Martchev*

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