What began in early June with a surprisingly strong showing at the ballot box for the pro-Kurdish HDP has now ended precisely where many knew it would: with new elections.
After allegedly working behind the scenes to undercut coalition negotiations, President Recep Tayyip Erdogan will now send Turkey back to the polls on November 1. As a reminder, here’s a short recap of recent events:
The lira has been putting to new lows against the dollar on an almost daily basis as confidence suffers from a worsening political crisis which began in June when AKP lost its parliamentary majority for the first time in over a decade throwing President Recep Tayyip Erdogan’s plan to transform the country’s political system into an executive presidency into doubt. Not one to give up easily (especially when it comes to consolidating his power), Erdogan proceeded to launch an ad hoc military offensive against the PKK in an attempt to undermine support for the pro-Kurdish HDP ahead of new elections.
Thanks to the ISIS decoy [11], Erodgan’s crackdown on the PKK - and, by extension, his willful subversion of Turkey’s tenuous democracy - has the blessing of Washington and NATO.
On Friday, Erdogan took the opportunity to explicitly blame HDP for the violence, saying the party’s claims that they aren’t separatists are "lies from A to Z."
And as for CHP’s seemingly reasonable request for a mandate to form a government in order to avoid sending voters back to the polls, Erdogan says he won’t be "losing time" with that. Why not, you ask? Because the party’s leader, Kemal Kilicdaroglu, refused an invitation [12] to visit Erdogan at the President’s newly constructed, $600 million, 1,150-room palace. "Why should I invite someone who doesn’t know the road to Bestepe?" he asked reporters on Friday.
Meanwhile, consumer confidence in Turkey crashed to its lowest level since 2009, and it’s no wonder, what with the lira set up for more pain ahead, even as it’s already sitting at record lows against the dollar. As for stocks, well, the bear is here:
[13]
For anyone who hasn't followed the story closely, note that there is a very real chance that new elections will plunge the country deeper into civil war. Indeed some lawmakers have acknowledged as much. In fact, it's difficult to imagine a positive outcome. If AKP regains its majority and Erdogan proceeds to change the constitution (as planned) it will be seen by the Kurds as a validation of the regime's corruption. If HDP puts in a strong showing again, or if AKP is otherwise unable to regain its majority, one shudders to think what happens next, although it's probably safe to say that the fight against the PKK ISIS will intensify, which is just fine with the US because the more "terrorism" there is in Turkey, the greater the justification for flying combat missions into Syria from Incirlik.
Despite all of the above, no one should worry about the lira because:
- TURKEY'S ZEYBEKCI SAYS THERE'S NO REASON FOR CURRENT FX ANOMALY
For anyone curious to know more about all the reasons there are to worry about the "current FX anomaly", we've included excerpts from Thursday's analysis below.
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Turkey’s central bank hasn’t helped matters and the lira legged lower on Wednesday after it was made clear that a rate hike was not in the cards until Fed liftoff is official.
[14]
Citi has taken a look at the situation and determined that in fact, the lira is the most vulnerable of all EM currencies they track:
We believe it is going to be difficult for the local markets angle of the EM asset class, in this important (potential) transition of monetary policy in the US, and also taking into account any potential move by the ECB in 2016 (away from a QE stance). That prompted us to revisit our FX vulnerability model. In the model, we look into EMFX from three angles: 1) the macro vulnerability aspect (focused on BoP dynamics, FX reserve metrics, portfolio flows and CDS); 2) interest rate coverage (measured by 1y1y forward real rates, current implied yields and bond yield premium after hedging costs); and 3) our assessment of positioning by real money investors and leveraged accounts in the several EM currencies. TRY, BRL, ZAR, MXN and MYR rank high in terms of aggregate vulnerability.
[15]
While Morgan Stanley is calling for an emergency rate hike:
What can the CBT do? Given the rapid deprecation in TRY, the CBT could be in a dilemma to decide on the next step. Recent market development could push the CBT to deliver another emergency rate hike, as it did in January 2014. Our economists see the increasing risk of emergency rate hikes of 200bp on the lending rate (upper band). The market dynamic surrounding TRY has become more disorderly with TRY weakening in a low liquidity environment and without any implicit catalyst. This suggests a sharp deterioration in domestic confidence in the exchange rate, extending from investors to corporates and households ? such a dynamic has historically preluded some form of policy response, as we analysed above. While the underlying macro and political factors that have driven USD/TRY to current levels remain in place, and domestic security risks can certainly increase ahead of early elections, we are also more cognisant of the risk of a policy response amid oversold technical conditions on TRY. While real policy rates are positive, they are clearly not high enough to stabilise the currency, and the risk of an increase in rates has risen. We doubt any measures involving the sale of USD will be seen as credible and/or have much impact, as was the case in early 2014.
And then further from Citi:
On the hard currency front, USD leverage in selected economies is sparking once again fears of any systemic implications. It is true to say markets are still far away from a systemic trigger (serious USD funding issues), but we believe it is also correct to adjust CDS (and hard currency spreads in general) higher in curves of economies more dependent on USD funding. Indonesia, Brazil and Turkey are economies that could suffer more (in different magnitudes of course) from a continuous tightening of USD funding conditions. This is the underpinning factor behind our long Turkey CDS position.
[16]
And speaking of CDS, well it's blowing out to its widest level in three years:
[17]
