A Hard Landing Looms As Erdogan Doubles Down

As Turkey Reels, Erdogan Digs In

It seems that rather than offer any orthodox policy solutions, Turkish President Erdogan is doubling down on his confrontational stance. This spells more trouble for Turkish markets when they open this week. The rumored emergency meeting between Turkish regulators and banks did not materialize over this past weekend as announced.

As usual, Erdogan railed against higher interest rates, claiming they make the rich richer and the poor poorer.  He pledged that while he remains alive, Turkey won’t fall for the “interest trap.”  Erdogan played the victim card, saying that the financial stresses are another attack on him, like the attempted coup. He also stated that those calling for IMF aid want Turkey to give up its independence.

In terms of foreign exchange, Erdogan repeated his call for the Turkish people to convert their holdings into liras, the country’s official currency. He also defiantly said that it’s foolish to think that Turkey will stumble because of global FX markets. Erdogan said that he’s ready to respond with new financial tools against the dollar.

Turkish President Recep Tayyip Erdoğan.

In terms of international relations, Erdogan said: “The US is attempting to sacrifice an ally of 81 million for a pastor.” He said the responsibility for poor relations lies with the US. He added that Turkey is looking for new markets and alliances.

This is all vintage Erdogan.  Whilst it might play well on the campaign trail, this is not what markets want to hear right now.  Policymaking in Turkey remains top-heavy and run by Erdogan. Market-friendly officials have been eliminated from the cabinet or marginalized.

With Erdogan signaling no policy changes yet, we expect USD/TRY to easily make new all-time highs above the one from Friday near 6.87. 10-year local currency government bond yields cracked 20 percent Friday, and are also likely to march higher in lockstep with the weaker lira. With a hard landing for the economy becoming increasingly likely, Turkish equities should continue to sink.

In related news, Johns Hopkins University economics Professor Steve Hanke came out over the weekend and called for Turkey should adopt a gold-backed currency board. This is not the solution, some markets analysts explain, as Turkey’s problems are much too complex and wide-ranging. As the saying goes, “When the only tool you have is a hammer, every problem looks like a nail.”

“Turkey has not yet reached its pain threshold whereby it will shift to a more orthodox policy stance,” Win Thin, global head of emerging market strategy with Brown Brothers Harriman (BBH) wrote in a note to clients. “That means things will get much worse before they get better. But, he added, “make no mistake, Turkey is in for some serious pain.” If it keeps going down its current path, Turkey (and the market) has to be prepared for a hard landing, corporate defaults, and bank failures.

Markets are on heightened alert for contagion, but BBH continues to downplay this notion in favor of one that recognizes that emerging markets are in a broad-based bear market. “As such, we see continued underperformance by the lira, Argentine peso, Russian ruble, Brazilian real and South African rand due to idiosyncratic risk in these countries.”

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