Contagion fears return as Turkey keeps investors trapped in lira

The most vulnerable corners of emerging markets are bracing for turbulence as Turkey’s stand-off with investors begins to test the nerves of traders.

Currencies from South Africa’s rand to Brazil’s real are witnessing a spike in their expected volatility, signalling concern they may weaken the most along with the lira over the next month. The price-swings have evoked memories of last year when a meltdown in the Turkish exchange rate spurred panic selling across emerging markets.

Volatility in the lira has posted the biggest four-day surge since 2004 as officials adopt measures to create a scarcity of the currency to prevent a slump in its value. As overnight borrowing rates crossed 1 000%, traders have dumped the nation’s stocks and bonds days before an election that will test the popularity of President Recep Tayyip Erdogan.

Still, the reaction from elsewhere in global emerging markets has been muted. The MSCI EM Currency Index is down less than 1% since the turmoil erupted last week. Further losses will depend on what actions are taken by Turkish authorities.

Here are comments from money managers on the risk to other developing nations if Turkey fails to relax controls:

Nick Eisinger, co-head of Vanguard Asset Management’s global emerging-market active fixed-income funds in London:

“There is a risk of contagion and we are seeing a little bit of that in currency space such as Indonesia and South Africa.”

Brendan McKenna, a strategist at Wells Fargo Securities in New York:

“It looks like there is some contagion, mostly focused on the high beta currencies — the South African rand and the Brazilian real. That’s not that uncommon. Those currencies felt some pain after the lira crisis last year too. ”

Jason Daw, Singapore-based head of emerging-markets strategy at Societe Generale SA

“The surge in FX swap points seems related to idiosyncratic factors in Turkey rather than a broader squeeze in dollar funding costs. With that said, investors are probably concerned that there could be some contagion to other EM currencies given the experience last year. High beta EM is most at risk from a deterioration in sentiment, but for Asia it is important to realise that the direct trade and financial linkages are very small.”

Koon Chow, a senior strategist at Union Bancaire Privee in London:

“The impact is probably limited unless we see a trend depreciation of the lira. A one-off lira depreciation should not have, if it happened, much of an effect because we are in a climate of low Treasury yields and low volatility. Of course there is a risk of a knee-jerk impact given the price action across currencies in July and August last year. South Africa is most vulnerable because of its largish current account deficits.”

Marcin Lipka, a senior analyst at Cinkciarzpl in Poland:

“No contagion effect, at least so far. As the overall sentiment to emerging markets is neutral or somewhat positive. The local election in Turkey is troublesome. Erdogan’s AKP is losing support in the largest cities and the authorities are overly optimistic regarding the economy.”

Mitul Kotecha, senior emerging markets strategist at TD Securities in Singapore:

“We don’t expect there to be contagion. The issues seem to be very Turkey specific.” “The dislocations in the interest rate market seems to relate to a desire from the Turkish authorities to prevent TRY weakness ahead of the 31 March local elections. In this respect they seem to be succeeding.”

© 2019 Bloomberg L.P

Source: moneyweb.co.za