Forget Italy, Turkey Is The Main Course

While investors are focused on Italy, Bloomberg's Mark Cudmore warns that another Mediterranean country is poised to grab their attention very soon. A currency crisis in Turkey is rapidly deteriorating, setting the stage for dramatic and unscheduled central bank action.

The lira has weakened by more than 11% in the last six weeks against an equally weighted dollar-euro basket. This devaluation is exacerbating the situation rather than providing a relief valve.

Turkish corporates’ FX liabilities have expanded at an extraordinary pace in recent years. As of August, they exceeded their FX assets by $210.5 billion dollars -- an increase of 15% on the previous year.

So corporations are being forced to chase the move in the lira and buy even more foreign currency. Turkey’s citizens are understandably joining them, driven by anxiety over how this will end.

Over the weekend, President Erdogan pleaded for his compatriots to start converting their foreign currency savings back to lira. His words will be insufficient to stem outflows, especially as he used the same speech to again call for lower interest rates. That’s exactly what investors don’t want to hear.

Only a sudden large rate rise will stop the rout. The troublesome fact the president is actively fighting against the help that’s needed means the market will be more confident in selling the lira.

Global events aren’t helping. As a major commodity importer, the country’s terms of trade are starting to slump again in the wake of last week’s OPEC deal. Trump’s threatened geopolitical approach of reduced intervention is increasing the risk premium on assets in the region.

This movie has played out twice before in Turkey, in both 2006 and 2014, so traders should know how it ends. Erdogan will eventually lose, and the central bank will hike rates by several percent, striking further blows to a slowing real economy.

Get your fill of the Italian excitement today, but remember it’s just an antipasto. Turkey is the main course.