“As European stock markets bounced from their lows late on Monday, it was tempting to write off the global ramifications of Turkey’s currency crisis… investors and analysts are starting to see the country’s crisis as a harbinger of things to come in an era in which central banks are rolling back a decade of monetary stimulus.
“As the plentiful liquidity of quantitative easing begins to fade and access to the dollar tightens, investors will be less forgiving of policy mistakes by governments, shine a harsher light on borrowers who have racked up debts in the US currency and used the era of easy money to put off difficult decisions.
“After ten years of monetary policy anaesthetic, the number of sceptics is growing,” said Alberto Gallo at Algebris Investments…
“With an estimated $40tn added to the debts of emerging markets in the decade since the global financial crisis, according to the Institute of International Finance (IIF), parts of EM look most vulnerable.
“Indeed in June, Argentina was forced to seek a bailout from the IMF after its economy ran aground just a year after it sold a 100-year bond. The size of their debts leave both South Africa and Brazil vulnerable, analysts say. In a day of volatile trading for EMs on Monday, the South African rand at one point plunged about 10 per cent and Brazil’s real has endured a 4 per cent drop over the past four days.
“Traders are picking off nations exposed to dollar obligations,” said Peter Rosenstreich, a currency analyst at the online bank Swissquote, pointing to Chile, Mexico, Indonesia, Russia and Malaysia among those countries with high non-bank dollar debt as a percentage of GDP.
“The biggest debt mountain belongs to China. It stood at 300 per cent of GDP in the first quarter, up from 171 per cent at the end of 2008, according to the IIF, although most of that debt is held inside the country…
“As the European Central Bank reins in its bond-buying programme, investors say the confidence factor will also be critical as Italy’s populist coalition prepares to unveil a budget that some expect to be fiscally aggressive. Italian government debt was a notable laggard on Monday, with the yield on the ten-year benchmark rising 11 basis points to 3.09 per cent.
“Mr Gallo said he expected investors to view Italy by the same yardstick that the market had judged Argentina and Turkey, questioning governments that “sell people a dream, create an enemy, and pursue unsustainable policies in the process”. Italy’s deputy prime minister Luigi Di Maio told Corriere della Sera that the government “cannot be threatened” by the markets.
“Trinh Nguyen, senior economist for emerging Asia at Natixis in Hong Kong, said: “Contagion on financial markets has to do with risk-on, risk-off sentiment and it impacts the countries that depend on [foreign finance].”
“…China remains vulnerable to the escalating trade war with the US, as shown in a 16 per cent drop in its stock markets this year, and other EM are vulnerable to a slowdown in China. But even this is a secondary consideration against a background of rising US rates and a stronger dollar.
““What is really driving emerging markets is the tightening of dollar liquidity,” Ms Nguyen said.”
“A fresh plunge in the Turkish lira sent tremors through global currency markets on Monday, amid fears that the failure of Recep Tayyip Erdogan’s government to tackle its worsening financial crisis would have a domino effect on other vulnerable countries.”
“…the collapse of confidence in the lira spread to the South African rand, which fell by as much as 7 per cent against the dollar, while the Indian rupee sank to a record low against the greenback, dipping close to 70 per dollar.”
“It isn’t just sovereigns. Argentine and Turkish corporate bonds are also racing each other to the bottom. Of the 10 worst-returning dollar-denominated, emerging market corporate bonds this month, six are Turkish and four are Argentine.”
“Because the [Turkish] crisis involves private rather than public debt, the IMF could find it harder to justify a bailout. The moral hazard of using IMF funds for corporate debt issues would be substantial.”
“This turmoil is about far more than the price of onions in Istanbul. Turkey’s many troubles have wide geopolitical and strategic ramifications.”
“From a strategic or military point of view, Erdogan “looking for new friends” is even more worrying. Turkey suddenly has a lot in common with Iran, Syria, and, across the Black Sea, Russia: They are all the targets of US sanctions… The worst-case scenario is a Turkish government that cannot pay the army that controls its borders, in search of “new friends” to bail it out.”
“In response to the U.S. sanctions that came into effect last week, Iran has threatened to block access to the world’s busiest oil shipping route. There has been no indication that Iran is prepared to go through with its threats, but if it did, it would likely be catastrophic for the region, and for global energy prices.”
“Argentina took emergency steps to stabilize its currency in the wake of an emerging-market rout caused by Turkey’s crisis, jacking up its already highest-in-the-world interest rate by 5 percentage points and announcing it will sell $500 million to support the peso. Policy makers set the rate for seven-day notes at a record 45 percent and pledged to keep it at that level at least until October.”
“In normal times you would expect such an economic signal would drive the loonie higher. Instead, a few hours after the jobs results the Canadian dollar was down nearly half a cent.”
“America never made up the growth it lost in the 2008 global financial crisis and the recession it triggered. A decade later, U.S. households are still counting the cost. GDP remains well below what its 2007 trend would have implied and it’s unlikely the economy will ever make up that lost ground, according to research from the Federal Reserve Bank of San Francisco published Monday. The hit will cost the average American $70,000 in lifetime income, they estimate.”
“More than 1 million student loan borrowers each year go into default. Outstanding education debt in the U.S. has tripled over the last decade and now exceeds $1.5 trillion, posing a greater burden to Americans than auto or credit card debt. For many, the payments are proving unmanageable.”
“Italian Minister Claudio Borghi called for capped yield spreads on Eurozone bonds – “The situation can’t be resolved and it is going to explode” he… said, referring to the shared euro currency. His suggested remedy was a 150 basis point limit on the spread between Eurozone country’s bonds. “Either the ECB offers a guarantee or the euro will be dismantled,” he concluded.”
“Russia’s grain exports have started to show the first signs of a slowdown since quality concerns over this year’s crop pushed prices to five-year highs.”
“China’s economy is showing signs of cooling further as the U.S. prepares even tougher trade tariffs, with investment growth slowing to a record low and consumers turning more cautious about spending, data showed on Tuesday… The pace of fixed asset investment was the weakest on record going back to early 1996, according to data on Reuters Eikon… Retail sales also missed expectations.”