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Capital Market Update: Turkey in the Spotlight



Emerging market fixed income and equity indices remain under pressure. Over the last few trading days, indexes tracking both equities as well as fixed income investments in emerging markets have reached new lows for the year.

The chief catalyst for the recent sell-off is the current turmoil in Turkey, where a potential financial crisis is unfolding. The pieces for such a situation have been in place for some time: a large dependency on foreign capital for domestic investment, high levels of foreign debt, inadequate levels of foreign exchange reserves to cover emergencies and spiraling domestic inflation.

What has caused Turkey’s simmering financial situation to rise to nearly a full-on boil?

  • First, rising U.S. interest rates have made U.S. based investments more competitive with emerging market investments, as the yield on a 2-year U.S. treasury note is now roughly equivalent to the dividend yield on the emerging market equity index. This causes investors to sell emerging market assets in favor of traditionally safer opportunities. Higher interest rates also raise the cost for Turkey to borrow, as their borrowing costs rise to compete for lenders with rising U.S. interest rates.
  • Second, the traditional monetary response in Turkey’s financial situation is to raise domestic interest rates. However, the Turkish central bank has been slow to respond, fearing that a response would signal weakness. This has led foreign investors to question the determination of the Turkish central bank to pursue painful but necessary policies.
  • Third, political tensions between Turkey and the United States have intensified over Turkey’s ongoing imprisonment of U.S. pastor Andrew Brunson and calls for his release by the U.S. administration.

Despite recent market volatility, we do not expect the Turkey situation to boil over and cause meaningful damage elsewhere. The Turkish economy is relatively small in the global context, representing less than 1.5% of global GDP. Global economic momentum is mixed, however we have seen some positive momentum in a few key regions, most recently Germany and the U.S. The risks stemming from Turkey’s current economic woes are focused chiefly on currency movements as well as the risk posed to companies with loan exposures that could be challenged by Turkish troubles.

Emerging market investing

Investors have responded to the situation in Turkey by broadly selling off assets across emerging markets, despite Turkish assets representing small weightings in emerging market equity and fixed income indices (around 5 percent). While other countries such as Argentina are in similar challenging economic circumstances, most countries across emerging markets are in solid fundamental shape and the current sell-off is not reflective of overall crisis conditions. Economic growth is reasonably healthy, as many countries retain strong levels of foreign exchange reserves, and are already taking proactive responses such as Indonesia’s recent interest rate hike.

While it is difficult to determine exactly when these risks might begin to abate, capital markets may continue pressuring Turkey to respond more significantly than it has to date. In the meantime, we expect additional headlines to materialize and the potential for more near-term volatility across asset classes and currencies; however, our base case is for more of a contained impact.

Please don’t hesitate to let us know if you have questions on how this impacts your particular situation.

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This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness.

International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.


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