Yesterday when we discussed the dramatic crash in the Turkish lira, resulting from the visa suspension drama at both Turkish and US consulates, we noted that "this is the currency's seventh consecutive decline, after dropping on Friday amid concern Fed tightening would hurt EM currencies, and should it persist may finally have an adverse impact on other EM currencies, not to mention various other local Turkish asset classes when markets reopen in a few hours."
Well, it's now a few hours later, and as expected the selloff has spread, with the Borsa Istanbul 100 Index dropping as much as 4.7% to the lowest since June 21: the selloff was the biggest one-day drop since the "failed coup" of July 18, 2016; with the index breaking below 100-DMA, and now in a correction, down 10% since peak in late August. Among biggest decliners on Monday are Turkish Airlines, down 8%; Karsan Otomotiv (-8.9%), Zorlu Enerji (-8.4%), Dogan Sirketler Grubu (-8.3%)
As for the Lira, it continued sliding and at one point the session drop was a large as 8%.
But more importantly, overnight the risk of EM contagion stemming from the Turkish crash was also the topic of the latest note from Mark Cudmore - Bloomberg's versatile FX and macro strategist - who just like us, believes that unless the TRY crash is stabilized, it could lead to a broader EM rout. As Cudmore notes, "International investors have been gobbling up Turkish debt this year. Those positions were beginning to look vulnerable as the lira led the broad emerging-market FX correction that started almost a month ago. Such investments became more vulnerable last week, when Turkish inflation data confirmed prices are spiraling out of control and real yields in the country are too low. The move toward the exit by bond holders may soon become a stampede."
More importantly, there is precedent: "In 2006, the MSCI Emerging Markets Index sold off 25% in five weeks. That happened in the middle of the golden age for EM and a multi-year bull market for the asset class. Back then, there didn’t seem to be anything wrong until the Turkish lira suddenly blew up in early May. That prompted position trimming across EM, which then triggered stop losses across the sector in a negative loop."
Finally, Cudmore warns that "the pain may not be limited to EM. The asset class has been one of the most resilient and entrenched trades of 2017. As losses and volatility both mount in EM, it’s likely to lead to position trimming and higher volatility elsewhere as well."
If Cudmore is right, keep an eye on the chart below: it could be the catalyst for the much anticipated and long overdue correction in EM... and from there spread to developed markets....
Here is the full Macro View note from Cudmore:
This Lira Sell-Off Isn’t Just a Turkish Issue
The losses in the Turkish lira are sizable enough to cause contagion. Investors everywhere should prepare.
The lira is being hit by an escalation in political tensions with the U.S. Outside Turkey, most assets are calm this Monday. Don’t be lulled into a sense of complacency.
This is the largest lira drop since the attempted coup on July 15, 2016, and the currency is at its weakest level ever versus the euro-dollar basket. That doesn’t just matter psychologically. It also puts real pressure on Turkey’s massive FX liabilities.
International investors have been gobbling up Turkish debt this year. Those positions were beginning to look vulnerable as the lira led the broad emerging-market FX correction that started almost a month ago.
Such investments became more vulnerable last week, when Turkish inflation data confirmed prices are spiraling out of control and real yields in the country are too low. The move toward the exit by bond holders may soon become a stampede.
Investors in other EM countries will be compelled to take note as value-at-risk measures climb; developing-nation currency volatility has already been marching higher since August. With a stronger dollar and higher U.S. yields, the macro environment is looking a lot less friendly than it was a month ago.
High-yielding, high-volatility EM currencies like the South African rand, the Brazilian real and the Mexican peso may be the first places where contagion shows up.
The pain may not be limited to EM. The asset class has been one of the most resilient and entrenched trades of 2017. As losses and volatility both mount in EM, it’s likely to lead to position trimming and higher volatility elsewhere as well.
In 2006, the MSCI Emerging Markets Index sold off 25% in five weeks. That happened in the middle of the golden age for EM and a multi-year bull market for the asset class. Back then, there didn’t seem to be anything wrong until the Turkish lira suddenly blew up in early May. That prompted position trimming across EM, which then triggered stop losses across the sector in a negative loop.
That’s just a reminder that market corrections often begin in unexpected places and unpredictable ways.