Turkey Trouble

Turkey’s recent economic woes have highlighted similar challenges that other emerging markets (EM) are facing amid rising U.S. interest rates and a stronger U.S. dollar. In the wake of the Fed’s third rate hike, several EM currencies saw substantial currency depreciation.

Turkey’s currency crisis is somewhat worse compared to most EMs due to years of loose monetary and fiscal policies, exacerbated by recent steel and aluminum tariffs announced by President Trump. The Turkish Lira reached a record low against the dollar on August 13th, almost a 40% fall in 2018. This is partly a response to President Erdogan’s pressure on the central bank to keep interest rates low, but also worsened by a highly publicized diplomatic spat with the U.S. As a result of the weak Lira, Turkey’s current account balance recorded a USD 2.6 billion surplus – the first surplus in three years.

As a response to the increased investor angst that borrowers won’t be able to pay back their debts, the price to hedge against a Turkish debt default rose to the highest level in almost a decade. The 5-year CDS spread climbed to 400 bps in August and even reached 574 bps in September.

Borrowing costs have risen sharply as investors require higher interest rates to compensate for the growing inflation and currency depreciation. The yield on the nation’s benchmark 10-year government bonds reached its all-time peak at 21.5%.

EM asset prices often overshoot, and recent turmoil in Turkey may present interesting investment opportunities for a bounce in 4Q 2018 – in credit, currencies, and the stock market.