Turkey Traders Balk at U.S. Sanctions as Threats Become Reality

(Bloomberg) -- U.S. sanctions couldn’t have come at a worse time for Turkey.

The lira is already buckling under the weight of one of the widest current-account deficits in emerging markets, inflation is running well into the double-digits and the central bank’s credibility is shot as investors lose faith in its ability to anchor prices under President Recep Tayyip Erdogan’s watch.

While many investors were irked when President Donald Trump threatened to impose “large sanctions” on Turkey last week over the detention of an evangelical pastor, the U.S. Treasury Department’s decision on Wednesday to sanction two Turkish government ministers is a sign that his administration is making good on that pledge. And it sent Turkish markets tumbling.

“It’s a disaster given how fragile the Turkish economy and the markets are to any negative news that may affect foreign flows,” said Michel Danechi, a portfolio manager at Vedra Partners Ltd. in London.

The lira weakened as much as 1.9 percent to a record, passing 5 per dollar as it extended its slide this year to more than 25 percent. The yield on 10-year government bonds soared to as high as 19.48 percent, also a record, while the benchmark Borsa Istanbul 100 Index fell as much as 3.2 percent.

Here’s a roundup of what investors and economists are saying about the potential impact of U.S. sanctions on Turkish markets:

Cristian Maggio, the head of emerging market strategy at TD Securities in London:

  • “It’s bad. It’s a rare episode of sanctions among NATO members. It’s not a decision that is taken lightly. So this is not just headline risk, and it will likely bear visible and measurable economic and financial consequences.”
  • The lira will go “possibly significantly higher as there are no technicals now, whether one believes or not in the technical voodoo.”
  • “That said, the underlying risk is real. Diplomacy has never been that bad in many years; the economy is slowing and there’s a concrete risk of a hard landing; from a financial viewpoint, the Turkish central bank will be forced to hike again unless the upside move in USD/TRY reverses, but I’m afraid it won’t.”
  • “So what’s next? A further extension of the lira slide comes almost certainly with central bank consequences.”

Anastasia Levashova, a fund manager at Blackfriars Asset Management in London:

  • “There are several big diplomatic questions between the U.S. and Turkey. And they will not be resolved fast. So Pastor Brunson is just the visible part of the iceberg at this point.”
  • “Turkish markets’ performance will depend on global risk appetite as Turkey is one of the most risky bets; U.S.-Turkey relations and the ability to compromise from both sides given both countries have now bold and strong and recently empowered leaders; and last but not least Turkey’s own domestic economic policies.”

Michel Danechi, a portfolio manager at Vedra Partners Limited in London:

  • “It’s a disaster given how fragile the Turkish economy and the markets are to any negative news that may affect foreign flows. In my view it is too painful to do otherwise, so Turkey will have to make concessions or amendments. Better sooner than later.”
  • “Further pressure in the short term is probably limited at this point, unless Europe joins in and/or the chance of an interest-rate increase vanishes totally.”

Nigel Rendell, a senior analyst at Medley Global Advisors in London:

  • “The market lurches from one negative event to another, be it ever-higher inflation, central-bank inaction, post-election uncertainties, and now the sanctions from the U.S. The net result being the erosion of foreign appetite for Turkish assets and an ever weaker lira. The sanctions come at a particularly difficult time for the Turkish economy.”
  • “Inflation is running out of control and the central bank is giving the impression that it doesn’t seem to care. Ultimately, policymakers will have to raise interest rates further. It is six weeks until the next policy meeting in mid-September and if the lira continues to fall in the way that it has done over recent months the chances of another emergency central-bank meeting in the intervening weeks is growing.”
  • “Central bankers were hoping to have a summer holiday, but they may have little time to relax on the beach before they find themselves having to repack their suitcases and scuttle back to Ankara for another hastily convened emergency meeting.”

Trieu Pham, an emerging market credit strategist at ING Bank NV in London:

  • “It is unlikely that we see sanctions similar to those in Russia, which have been linked to the Countering America’s Adversaries Through Sanctions Act (CAATS). Sanctions against entities not directly involved in the arrest of pastor Brunson are therefore unlikely although the risk of a further escalation remains.”
  • “For Turkish credit, we see a period of uncertainty weighing on credit spreads until the situation normalizes. Despite the low risk of Turkish entities with bonds outstanding being targeted, the recent steps mark a new level in bilateral ties. A normalization might take time as the November 2015 jet shoot-down incident between Turkey and Russia has shown, when it took almost a year before ties normalized.”
  • “There is some room for optimism given that the U.S. and Turkey are NATO partners and depend on each other to a larger extent. In the short-term, any moves might be exacerbated by reactions taken by Turkey and the US.”

Carsten Hesse, an economist at Berenberg Bank in London:

  • “It is a very dangerous situation for Turkey; it seems like Turkey does not take the sanction risk seriously. Turkey’s economy very much depends on capital inflows to finance its massive current-account deficit.”
  • “Investors are already nervous due to the overheating of the economy and the central bank not doing enough to reach its inflation target. Investor confidence in Turkey has suffered a lot and the threat of serious sanctions will make investors even more careful before investing in Turkish assets.”
  • “If the U.S. follows up with serious sanctions we could see a further large drop in the Turkish lira, leading to a further increase in inflation expectations.”

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