The Weekly: Is Turkey a canary?

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20/08/2018
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Last week we discussed a so-called black swan event which has the capability to inject fear into financial markets across the world almost immediately.  The collapse of the Turkish Lira has not drawn any comparisons to a black swan event as yet – contagion fears are limited, after all a turkey cannot fly nearly as well as a swan!

However, perhaps this is just the first domino in one of many that could escalate into a full-blown crisis? More like a canary in a coal mine?  Venezuela’s troubles are already well documented, but they are back in focus this Monday as the socialist president, Nicolas Maduro, aims to bring the country’s rampant hyperinflation back under control.  The introduction of a new currency, the new sovereign bolivar replaces the ‘strong’ bolivar in a move that will see a currency devaluation of 95%.  However, according to the IMF, hyperinflation is still expected to peak at over 1,000,000% this year.

What we find staggering is that Venezuela is pegging this new currency against their very own cryptocurrency, the Venezuelan Petro. This was an attempt to get round US sanctions, but Donald Trump has since said that any sanctions will extend to the Petro. This cryptocurrency will be backed by Venezuela’s oil reserves and ultimately, the hope will be to stabilise the Venezuelan economy as well as the new currency. Even the more reputable cryptocurrencies such as Bitcoin are anything but stable, so we envisage things will get even worse before they get better for Venezuela. The new currency will almost certainly crumble within a few months if hyperinflation is not brought back under control.

Turkey is not Venezuela however, and all the problems are not necessarily the same. Saying that, both leaders like to point out that their economic plight is not of their own making and like to blame outside forces, like Donald Trump.  It can also be argued that Venezuela is not an emerging market like Turkey. However, both countries have large piles of debt, mostly denominated in US Dollars.  This essentially is where the concern lies, and it’s easy to see why.

Since the financial crisis in 2008, interest rates in the developed world have been at historic lows. Investors looking for a better return have thus looked farther afield, and so have invested heavily in emerging markets; both government debt and corporate debt. The problem now is that interest rates are moving back up in the US and the UK; and the EU will soon follow, when their quantitative easing programme comes to an end. This not only encourages investors to pull their money out of emerging markets for a better return at home but it leads to a devaluation of their currency. As many emerging markets have borrowed heavily, it is going to make paying this debt much more expensive. The major rating agencies are not doing much to help either, with both Standard & Poor’s and Moody’s cutting Turkey’s sovereign credit rating to junk, which although probably accurate, is only making their plight worse. This effectively limits them from borrowing more money but if they do, it will be at significantly higher interest rates.

South Africa, another emerging market, has another reason to give investors a potential headache, on top of a depreciating currency.  Land reform is always going to be controversial, and concern is mounting around the ANC party and its consideration of introducing legislation to allow for the expropriation of land without compensation. For most investors, property law remains a cornerstone of a stable economy, government, and fundamentally the country. Many investors will only be too aware of the controversial land reforms in Zimbabwe and how it went from having one of the strongest economies in Africa to one of the weakest.  Should South Africa decide to pursue this controversial measure, then the aftermath of these land grabs need to be thought through.  Not only would they need to ensure that there are the necessary agricultural skills in place, but also further work will need to be put into other areas of the economy to offset any fall in agriculture. However, the biggest concern for the ANC would be how to combat the outflow of monies and investment from South Africa. Currently the South African Rand is already at a two year low against the US Dollar and Euro. Put another way, 40% of South African GDP is owed in US Dollars and Euros.  Without too much difficulty, it’s easy to see it falling further.

In conclusion, whilst none of these events in isolation necessarily has the potential to destabilise financial markets, there are concerns that several incidents together could culminate in the turning point of one of the longest bull runs in recent times.  Those with grey hair may remember the Latin American crisis of the 1980s which bears comparison with today.  Market commentators are always right about the bull market coming to an end; this isn’t down to their superfluous intuition.  It is a fact that bull markets always eventually come to an end, but in our opinion it won’t be one specific event, but a culmination of perhaps several different events. A domino effect could well become a black swan, however, there are still many positives for the global economy as a whole, so it will be interesting to see how it copes with these debt-fuelled stresses as interest rates rise in the US. Canaries and black swans couldn’t be more different but they are related and similarly difficult to spot.

 

Sterling weakness continues whilst inflation rises once again

Sterling continued to bear the brunt of persistent Dollar strength last week, maintaining its recent bout of weakness across currency markets. It closed the week -0.3% lower at just $1.27, having fallen by more than -5.5% against its American peer over the course of the last 3 months.                                       

Whilst moderately better, the domestic currency has also fallen by more than -3.0% against the Euro and continues to hover around the €1.14 level. Last week also saw the latest CPI release which showed inflation back on the move. It rose for the first time in 2018 to 2.5%, unsurprising considering the trajectory that Sterling has been on recently.

Global equity markets also had a largely disappointing week (with the exception of the US). Domestically, both the FTSE100 and FTSE250 went into reverse, declining by -1.4% and -1.1% respectively. In Europe, the French CAC40 struggled to a weekly fall of -1.7% with the German DAX30 faring slightly better after a -1.3% decline. The only major stock market to finish Friday in the black was the S&P500 which continued its impressive run with a +0.6% gain. Japanese equities meanwhile, were largely flat.

In the commodity markets, oil prices were subdued after another rise in US inventories. The strength of the Dollar is also causing major problems, especially in the emerging markets – in Turkey for example, imported oil is more than 60.0% more expensive year-on-year after the collapse in the Lira. This compares to oil prices which are up around 7.0% over the same time frame. Last week saw Brent prices decline by -1.4% to $71.83 a barrel. Gold also continued to feel the pressure of a strengthening greenback with the precious metal falling by -3.0% to $1,179 an ounce.

Bond markets on both sides of the Atlantic had an uneventful week with both 10-year Treasury and Gilt yields flat at 1.28% and 2.88% respectively despite favourable economic indicators.

 

Week ahead

Key policy makers from central banks around the globe will gather later this week for the annual policy symposium in Jackson Hole, Wyoming. Federal Reserve Chairman, Jerome Powell is set to deliver a Friday morning speech on "monetary policy in a changing economy". Investors will be looking for any guidance on the likely path of interest rates and quantitative tapering policy, as well as Powell’s take on economic growth amid a year of global trade wars.

In the meantime, the Federal Reserve’s latest policy meeting minutes are published on Tuesday whilst the European Central Bank is also due to publish its own meeting notes on Thursday. Economic data is limited this week. The most notable data release is US Durable Goods Orders which is scheduled for Friday.