Economic turmoil in Turkey rattles global markets

David Joy – Chief Market Strategist, Ameriprise Financial
Weekly markets commentary — Aug. 13, 2018


U.S. equities slipped for the first time in six weeks, as worries over economic turmoil in Turkey pushed investors to the sidelines. After rising to within a half percent of its January record high on Tuesday, the S&P 500 fell for three straight days to end the week fractionally lower. And after falling to its lowest level since January earlier in the week, the VIX index of implied equity volatility spiked higher. The sudden rise in risk aversion also resulted in a sharp drop in bond yields. The yield on the U.S. ten-year note fell eight basis points to 2.87 percent, after having briefly poked its head above the 3.0 percent threshold the previous week. And after two months of relative stability, the DXY dollar index surged to its highest level of the year. The yield on the German ten-year note fell nine basis points to 0.31 percent. 

The loss of confidence in the Turkish economy has been most evident in the currency. The Turkish lira has been experiencing a steady decline in value throughout the year on concerns over rising inflation, a large current account deficit, worries that the independence of the central bank has been compromised and a diplomatic spat with the U.S. At the end of February, it took 3.8 lira to buy one U.S. dollar. By August 3, the lira had fallen to 5.1, having lost roughly a third of its value relative to the dollar. Last week, however, saw a sudden spike lower, as the lira plunged another 25 percent to end the week at an exchange value of 6.4 against the dollar. 

Economic conditions in Turkey weigh on Eurozone and emerging market stocks

In dollar terms, stocks in Turkey plunged 22 percent last week, and have declined a total of 52 percent since the currency slide began in late February. The concern over Turkey also spread to Eurozone equities more broadly. The EuroStoxx 50 index fell 1.6 percent on the week, after having fallen 1.3 percent the previous week, as investors assessed the region’s banking exposure to Turkey. Emerging market equities held up relatively well, although the MSCI Emerging Markets dollar-based index fell 1.0 percent last week, after having fallen 1.7 percent the prior week. 

Stocks in Europe are broadly lower in early trading as this week gets underway, following broad-based weakness overnight in Asia. U.S. equity futures are also pointing to a weaker open. The Turkish central bank released a statement saying it will, “Take all necessary measures to maintain financial stability,” but investors remain skeptical as the lira is sharply lower once again as this week’s trading gets underway. 

Consumer prices on the rise; a strong earnings season comes to an end

The sharp drop in U.S. bond yields last week belied the rise in consumer prices. The July consumer price index rose 2.9 percent, matching the June total as the highest rate since February 2012. The core rate, however, rose to a new high for this cycle at 2.4 percent, a level last seen in 2008. Expectations for another Fed rate hike in September were unchanged on the week, with a 94 percent probability, according to the CME Fedwatch tool. Expectations of a fourth hike, in December, declined slightly to 61 percent. 

The domestic economic calendar this week includes reports on July retail sales, industrial production, housing starts, leading indicators and consumer sentiment. And second quarter earnings season is in its final stages. According to Factset, the growth rate is on track to exceed 24 percent for the quarter, virtually matching the first quarter increase. But all of that will take a back seat to the turmoil in Turkey, as investors monitor whether the words of policy makers are matched by credible actions. If not, the question becomes to what extent that weakness spreads elsewhere, and to what extent risk appetites decline further.