Turkey: Connect the Dots

Mid Week Bond Update

Turkey: Connect the Dots

So far, the flight to safety amid Turkey's currency crisis has been notable for its focus on genuine links between markets and institutions.

Turkey, Argentina, South Africa, European Union: Connecting the Dots

The events leading up to the recent run on the Turkish lira are well-documented - a perfect storm of high and rising inflation, populist interest-rate policy, a captive central bank, and conflict involving foreign nationals. All this, amplified by the normalization of rates by the U.S. central bank, the weaponization of U.S. trade, and the exposure of European and Emerging Market banks to a wider spectrum of global debt.

 

Source: Bloomberg, August 14, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

One feature of this round of market upset: the flight to safety over the past couple of weeks has so far focused more than usual on the genuine links between markets and institutions. For example, on August 10, in the midst of the Turkish lira’s fall, Argentina’s central bank quickly moved its already steep 7-day rate up 500 basis points to 45%, anticipating a rapid withdrawal of hard currencies from EM investment funds. In contrast, South Africa, already dealing with its own internal financial and political woes, declined to intervene as the rand slid briefly to 15.55 per U.S. dollar before recovering to about 14.25 later on August 13.

Rather than overreacting in the heat of the moment, the European Central Bank held its fire, declining to intervene, at least for now. All in all, reaction in financial markets, though severe, was well-focused.  Whether Turkey’s currency crisis will ultimately evolve into a debt crisis or a liquidity squeeze is another matter entirely.

On the rise: Curve Steepening, U.S. Treasuries

An 8 basis-point (bps) rise over 20 trading days isn’t large, but it’s certainly noticeable – especially when it involves the closely-watched 10-year Treasury.

 

Source: Bloomberg, August 14, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

Over the past 20 trading days, the 10-30 spread has widened fairly steadily to roughly 5.8 bps.  That rise is despite the 2.9 bps rise in the 10-year.

Which means that on its own, the 30-year has risen about 8 bps over the past 20 trading days, and as much as 16 bps at one point (August 1).

Which, in turn, could mean that the long bond might be telling a tale of improving prospects for growth, rather than a gloomy recessionary scenario some 18 months from now.

 

On the slide: The risk in European banks?

A key measure of Europe’s exposure to Turkey might be subsiding. At the close of U.S. trading on August 14, the value of credit default swaps (CDS) on the 5-year debt of three European banks is sending a signal that the default risk of these three corporate notes1 is pulling back.  By comparison, the CDS of Turkey’s 5-year sovereign debt continues to climb.

 

 

Source: Bloomberg, August 14, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

Make no mistake – there is plenty of exposure to Turkey to be found in these three banks, and probably others.  But for now, financial markets appear ready to reduce the price required to insure against default of the five-year notes of these three institutions. It’s no surprise, however, that the market is unwilling to do the same for Turkey’s 5-year sovereign debt.

 


1 A “note” is a fixed-income instrument with maturity of between 1 and 10 years. 

All Data: Source: Bloomberg, August 14, 2018, unless otherwise specified.

 

Definitions:

A credit default swap (CDS) is designed to transfer the credit exposure of fixed income products between parties.

A swap spread is the difference between the negotiated and the fixed rate of a swap.

Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.

 

 

 

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