Turkey left out of the party
Global growth is celebrating the tenth anniversary of the 2008 financial crisis. The party continues on Wall Street, supported by strong corporate profits. The Russel index, including the technology-driven NASDAQ and small companies, is reaching new highs.
Although the party’s host, the Fed, cuts down service from time to time and lowers the music, there is no intention of the guests to leave the party. The crowds, used to having fun for 10 years, are not convinced that the service will be closed and music will be completely shut down.
But not everyone is enjoying the summer holiday. Some of the emerging market investors who joined as party crashers did not like the music and began heading to the exit gate. Crowding at the doors can sometimes lead to panic and injury, like in concerts. It is not a general panic that drags the global risk appetite. We do not see an uncomfortable rise in valuations of safe-haven investment instruments such as gold and Japanese yen. However, a strong dollar and rising interest rates - and Trump’s foreign trade interventions - are leading to a deterioration in risk appetite for developing countries.
Despite the increase in volatility, global capital continues to prefer developed country stocks to corporate and state treasuries. We don’t see a sign that this will change in the short run. Developed countries’ stocks will continue to outperform company and state bonds. Advanced country radar shows that American stocks will continue to perform bet- ter than European assets. The political shocks in Italy and Spain are raising uncertainties over the economic policies to be implemented, raising Europe’s risk premium relative to the U.S. Despite Wall Street’s upbeat trend, emerging market risk premiums have begun to increase. After Argentina and Turkey, Brazil stands out also as the weakest link as asset sales intensify. As pressure mounts on emerging markets, the Turkish market tries to distinguish itself from other markets with interest rate shield protection. But despite the high interest rate, we can’t be sure we have succeeded in attracting foreign investors.
The interest rate shield was effective in containing the Turkish lira. The lira was the world’s highest-yielding currency with a real interest rate of over 5 percent (based on a 12 percent inflation forecast) after the last interest rate increase of the Central Bank. Short-term hot money began to re-enter Turkey.
However, there has not been a permanent positive distinguishing in stock markets, both in local bonds and in eurobonds. 10-year local bonds and 30-year Eurobond interest rates point to the highest risk premium after Argentina. At the Borsa Istanbul Stock Exchange, the discount continues to be over 40 percent for Turkey. Tightening of monetary policy saves time to solve the problems of Turkey’s long-standing issues. We need to rebuild trust to decrease Turkey’s risk premium, not a high interest shield. The way to do this is not to promise but to produce smooth economic policies.