Turkey’s crisis is starting to spread

BERLIN (Reuters) – As Turkey’s lira crisis deepens, contagion across all emerging markets has widened – dragging in the likes of South Africa’s rand, Argentina and Mexico’s pesos, Russia’s rouble and emerging market stock markets around the globe.

MSCI’s benchmark index of global emerging stock markets fell to near its 2018 lows, with many emerging Asia exchanges getting hammered.

Indonesian stocks, for example, fell more than 3 percent, with South Korean and Turkish stocks down more than 1 percent.

The ripple effects more generally were felt in bids for “safety” plays — U.S. Treasuries, German Bunds, Japan’s yen and the dollar more broadly.

Curiously, neither gold nor Swiss francs has been boosted.

Dollar/yen was undermined in part as Japanese household savers have typically held large amounts of high-yielding emerging market currency assets and pressure for redemptions and repatriation may now rise and be indiscriminate across the EM complex.

Contagion is also fueled by concern that fund managers who have lost heavily in Turkey or other emerging assets will look to sell more liquid parts of those portfolios to meet expected redemptions.

The other area of contagion is via western banks and creditors, who have direct exposure to Turkey and the worst affected markets and who will look to tighten credit or scale back operations there.

With several European banks, including BBVA, Unicredit, ING and BNP Paribas, owning Turkish bank stakes, the focus has been on the fallout in the euro banking sector and euro/dollar has sunk to its lowest in over a year as a result, dropping as low as  $1.1363 early on Monday before recovering to above $1.14.\

Wider European or U.S. economic or financial contagion beyond direct Turkish bank holdings is considered relatively limited, however.

European and U.S. stock futures were down about half a percent first thing Monday.

Dollar/lira soared to a record above 7.2 early on Monday before rebounding in wildly volatile trading.

Turkish officials flagged another set piece proposal to tackle the crisis later on Monday and the central bank moved to restrict currency swaps activity while loosening reserve requirements to provide extra liquidity to its ailing banks.

Some local banks suspended FX services for retail customers.

But there was no sign so far of the hefty interest rate rises of 5 percent points or more that many market participants say will now be required to address the loss of confidence in the lira.

And there is widespread concern about some form of capital controls being put in place as Turkey has neither adequate foreign currency reserves to intervene to buoy the lira or support its banks and is reluctant to seek conditional help from the International Monetary Fund, as would be typical in this sort of crisis.

With the lira now having lost 43 percent of its value so far in 2018, its weakening to levels above 7 per dollar is highly sensitive.

Goldman Sachs estimated last week that Turkish banks’ excess capital would be wiped out at roughly 7.1 per dollar, for example.

While Turkey’s economic policy management has been in question to date, the crisis has been exaggerated by a diplomatic and trade row with the United States, and President Donald Trump’s doubling of steel tariffs on Turkey on Friday added massive pressure to the currency.

There was little sign of any resolution to that row over the weekend.

A look at the day ahead from EMEA markets editor Mike Dolan. The views expressed are his own.