Turkey crisis sends tremors through emerging markets

Italian bond yields rise

LONDON/SYDNEY, Aug 13, (RTRS): The crisis engulfing Turkish markets over its diplomatic rift with the United States sent tremors through emerging markets on Monday, knocking some main currencies to multi-year lows and weighing heavily on equities.

Investors fear the selloff in the lira, which hit a fresh record low overnight, could have a ripple effect in global financial markets, with the euro, South Africa’s rand and Mexico’s peso already dented by Turkey’s crisis.

The lira pared some of its losses against the dollar after the central bank said it had lowered reserve requirement ratios for banks as well as pledged to provide whatever liquidity banks needed and to take all necessary measures to maintain financial stability.

However, the Turkish currency was still down more than 6 percent on the day and within spitting distance of a record low around 7.24 hit it early Asian trade. The lira has weakened nearly 45 percent since the start of the year.

Turkey’s local bond markets saw yields spike above 21 percent, while dollar-denominated bonds issued by the government and banks suffered a steep selloff. Istanbul’s stock exchange halted trading in three of the country’s leading banks after they tumbled more than 11 percent.

“It’s a textbook crisis - for many years everybody said Turkey was a weak country due to its large external debt and current account deficit,” said Guillaume Tresca, senior emerging markets strategist at Credit Agricole.

“There is nothing surprising other than that the central bank is not really reacting. They issued this new plan but there is no tightening of financial conditions - they are completely behind the curve.”

Other main currencies were caught in the vortex. South Africa’s rand skidded to levels not seen since mid-2016 and Russia’s rouble slumped to a near 2-1/2 year trough.

Slid

The Indian rupee slid to an alltime trough, while the Indonesian rupiah hitting a near three-year low prompted the central bank to intervene. China’s yuan weakened 0.5 percent - its steepest daily decline in nearly four weeks.

The wave of selling was triggered on Friday when U.S. President Donald Trump announced tougher sanctions on Turkish steel and aluminium exports, causing a spike in emerging foreign exchange volatility gauges.

Adding to the emerging market woes, Washington imposed surprise sanctions last week against Russia.

Some safe haven currencies and bonds rallied. The dollar index held near its one-year top of 96.522, while the Japanese yen climbed for a second straight day to a 1-1/2 month peak.

However, the sell-off was not limited to emerging markets: the euro stumbled to more than oneyear lows on worries about European bank exposure to Turkey.

Spain’s BBVA, Italy’s UniCredit and France’s BNP Paribas have some of the largest operations in Turkey among the euro zone banks.

The fear of contagion reverberated across equity markets.

MSCI’s broadest emerging markets index slipped 1.8 percent and traded within eyesight of a one-year low hit in June. The benchmark was pulled lower by hefty falls in Asian heavyweights South Korea and Hong Kong, where indexes fell around 1.5 percent, while Taiwan tumbled more than 2 percent.

Demand

The yield premium investors demand for holding Italian bonds over top-rated Germany rose to its highest since late May on Monday, propelled by political uncertainty in Italy and concerns about contagion from the financial crisis in Turkey.

Safe-haven German Bund yields fell to a one month low, but Spanish and Portuguese bond yields were dragged higher by their Italian peers and the broader risk off sentiment.

Italy once again stood out as the bloc’s underperformer, weighed down by conflicting comments from the government, global risk aversion and worries about the Italian banking sector’s exposure to Turkey.

Markets were unnerved on Friday by a report in the Financial Times that the European Central Bank was worried about European banks’ exposure to Turkey.

Euro zone bank stocks tumbled 1.3 percent to a six-week low on Monday as Turkey-exposed banks BBVA, Unicredit and BNP Paribas fell 0.9 to 2.6 percent.

“You have risk aversion and concerns about Turkey contagion risk hitting Italy against a backdrop of the Italian government not quite on the firmest footing,” said David Vickers, a senior portfolio manager at Russell Investments in London.

“You look for where there is fragility and the uncertainties surrounding Italian politics are more acute when you get global pressures.”

Speculators will probably attack Italian financial markets this month but the country has the resources to defend itself, Giancarlo Giorgetti - a senior and highly influential government official said in a newspaper interview on Sunday.

However, Deputy Prime Minister Luigi Di Maio said on Monday Italy was not at risk of a financial market attack and that his government could not be “threatened” by the idea.