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Threat of Turkish contagion weighs on emerging markets

Glenn Freeman with AAP  |  13 Aug 2018Text size  Decrease  Increase  |  
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The deepening currency crisis is putting pressure on emerging markets amid growing fears of a banking crisis, with mixed views on the potential for contagion.

Asian share markets are slipping and the euro has hit one-year lows as a fresh fall in the Turkish lira fuels demand for safe havens, including the US dollar, Swiss franc and yen.

The currency has fallen more than 40 per cent this year on worries over Turkish President Tayyip Erdogan's increasing control over the economy and deteriorating relations with the US, who last week doubled tariffs on steel and aluminium imports.

"The decline is caused not only by a weak external position in terms of current account deficit and inadequate currency reserves, but also the challenging political environment, which exacerbates the vulnerabilities in the lira," says Kerry Craig, JP Morgan's global market strategist.

He suggests a mid-meeting rate hike and tightening of monetary policy may go some way to helping avert the lira’s decline.

Modest spillover potential

Andrew Kenningham, chief global economist at Capital Economics, believes the lira's plunge will "push the Turkish economy into recession and it may well trigger a banking crisis".

"This would be another blow for EMs as an asset class, but the wider economic spillovers should be fairly modest, even for the euro zone," he added.

Turkey Erdogan lira currency

There are differing views on EM and broader market effects of Turkey's currency crisis

JP Morgan's Craig also believes any potential flow-on effects to other emerging markets would be only short-term: "The drivers of the lira’s decline are very specific to Turkey – therefore it should not derail the positive fundamentals in other emerging markets over a longer-term".

He notes the rise in the US dollar is a greater risk to Asian emerging markets in particular – the US-dollar index is up almost 4.5 per cent this year. "However, we expect the US economy to slow as a result of supply constraints and monetary policy, leading to a depreciation in the greenback over the medium term," Craig says.

Japan's Nikkei lost 0.95 per cent and MSCI's broadest index of Asia-Pacific shares outside Japan eased 0.3 per cent as bourses across the region turned red on Monday.

EMini futures for the S&P 500 were off 0.15 per cent, while Treasury yields dipped further.
Much of the early action was in currencies with the euro gapping lower as the Turkish lira took another slide to all-time lows around 7.2400 at one stage.

It was last at 6.8450, having found just a sliver of support when Turkish Finance Minister Berat Albayrak said the country had drafted an action plan to ease investor concerns and the banking watchdog said it limited swap transactions.

Kenningham notes Turkey's annual gross domestic product of around $900 billion was just 1 per cent of the global economy and slightly smaller than the Netherlands.

"Nonetheless, Turkey's troubles are a further headwind for the euro and are not good news for EM assets either."

How other currencies are faring

Indeed, the single currency sank to a one-year trough against the Swiss franc in early trade around 1.1300 francs, while hitting a 10-week low on the yen around 125.45 .

Against the US dollar, the euro touched its lowest since July 2017 at $US1.13715. It was last at $US1.1392 and still a long way from last week's top at $US1.1628. The US dollar eased against the safe haven yen to 110.65, but was a shade firmer against a basket of currencies at 96.388.

The Argentine peso and South African rand were also caught in the crossfire.

"Contagion risks centre on Spanish, Italian and French banks exposed to Turkish foreign currency debt, as well as Argentina and South Africa," warned analysts at ANZ.

"Turkey's massive pile of corporate debt denominated in foreign currencies, but a rapidly sliding currency - and inflation that's threatening to go exponential - is a toxic combination."

In commodity markets, gold had found little in the way of safety flows and was last stuck at $US1211.80 an ounce.

Oil prices edged higher with Brent up 5 US cents at $US72.86 a barrel, while US crude added 15 US cents to $US67.78.

 

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Glenn Freeman is senior editor, Morningstar Australia.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

. Glenn Freeman is senior editor, Morningstar Australia.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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