If you’ve been keeping up with the financial news over the last week, then you’ve probably heard of little other than Turkey’s currency crisis and its impact on global markets.
However, for all the noise currently being generated about the Turkey crisis, it can be difficult to tease out the key facts and the implications for your trading.
Let’s take a quick look at what’s happening with the Turkey crisis and what it means for markets and your trades.
A Crisis Long in the Making
Despite what many commentators may be suggesting, the current crisis in Turkey is actually long in the making.
Turkey has been promoting a policy of break-neck growth fueled by massive capital inflows, leaving the country with many debts that need to be serviced in foreign currencies.
While this would normally not be a problem in itself, the recent centralization of power under Erdogan has limited the freedom of Turkey’s central bank to pursue the necessary prudent monetary policies that would ensure that the Turkish lira can cope with these financing needs.
A Trump Catalyst
This perilous state of Turkey’s currency was exacerbated by a recent spat over a detained American pastor, which saw sanctions placed on two Turkish ministers close to Erdogan.
This was enough to send the already fragile lira into a freefall, with traders having no expectation that Erdogan will reverse his currently dangerous course with respect to US-Turkish relations or the independence of Turkey’s monetary policy.
Without a change of direction on either of these fronts, there is no reason for investors to expect anything but more bad news for the lira and the Turkish economy as a whole.
European Banks and Emerging Market Contagion
The impact of the Turkey crisis on global markets is two-fold.
The first area of concern is the few European banks that have significant exposure to Turkish assets. Many European banks already have weak capital ratios, and a sharp drop in asset values could see many teetering close to crisis level.
This concern for European banks has had a knock-on effect on the euro itself and European equities in general.
The second and more serious concern stemming from the Turkey crisis is a contagion of panic selling of various emerging market currencies around the globe.
Emerging markets are notorious for fast flows in and out of developing countries, and there were already concerns that emerging markets were at the top of the global economic cycle.
The crisis in Turkey only enhances the feeling that it is time to repatriate investments back into developed market currencies, and thinly traded emerging market currencies are particularly vulnerable to these fast-moving money flows.
The Future of the Crisis and the Impact on Trading
While the risk to European banks seems to be subsiding and the fears of a total emerging market rout overblown, the Turkey crisis is far from over.
Until Erdogan changes course on monetary policy at the least, there is no reason that the lira should see any kind of strong recovery beyond bouncing off the panic-induced lows of last Friday and this Monday.
That means that this crisis and its threat to emerging markets as a whole could simmer on for some time yet.
Any further problems in the notoriously unstable part of the world where Turkey resides could see a renewal of the current crisis, and a spread of contagion to other fragile emerging markets.