- The US-Turkey diplomatic fallout continues to weigh on the Turkish Lira, with USD/TRY hitting 7.00 earlier today before settling.
- If the crisis moves beyond Turkey and turns into a full blown emerging market rout, then the South African Rand is the currency most likely to be hit hardest.
USD/TRY's Gains Sustained for Now
Market participants around the globe continue to remain focused on Turkey at the start of the week, with fears growing that the issue will turn from an isolated incident to a full blow emerging market crisis.
Already today, rumors have proved potent catalysts for wild price swings in the Turkish Lira, with reports indicating that the jailed US pastor - the catayst that sparked the diplomatic fallout between the US and Turkey and subsequent tariffs - would be released from prison.
While the report was officially refuted, the stability it injected into markets this morning can't be discount. US equity futures have rallied, EUR/USD has moved back above 1.1400 (there are contagion ties here too), and USD/TRY has backed away from 7.00.
USD/TRY Price Chart: Hourly Timeframe (August 2018) (Chart 1)
While the stability in USD/TRY may be calming for market participants at present time, it won't do much to change the long-term calculus that the sharp depreciation in the Turkish Lira poses. It's just a matter of time before loan defaults occur and financial insitutions start eating losses (particularly European banks, which are on the hook to the tune of $194 billion, per the BIS).
If the Crisis Spreads, Who is Next?
The big question is, of course, what happens if the Turkey issue goes from an isolated incident to one dragging down the rest of the emerging market complex?
Comparisons to the 1997 Asian crisis surrounding Thailand are being thrown around liberally, with good reason. There are two key measures by which to determine if a country is at risk for a financial crisis onset by a dramatic collapse in its currecy. One measure is the country's external debt-to-GDP ratio, the other is its current account balance (as a percentage of GDP).
By 1997, Thailand's debt-to-GDP ratio was 65% and its current account balance (as a percentage of GDP) reached as low as -10%. Today, Turkey's debt-to-GDP ratio is 54% and its current account balance (as a percentage of GDP) is -5.4%. A similar situation, but not quite at the scale of Thailand in 1997.
If there is another country and currency facing a similar situation - at least, one that would make it a likely target if contagion spreads - would be one with a high external debt-to-GDP ratio and a negative current account balance (as a percentage of GDP).
The next closest country to Turkey, by these metrics, would be South Africa, which sports a 50% external debt-to-GDP ratio and a current account balance (as a percentage of GDP) of -2.9% (other contenders are Argentina and Colombia).
USD/ZAR Price Chart: Hourly Timeframe (August 2018) (Chart 2)
USD/ZAR has had a rough August but an even wilder past 24-hours, from midday on Friday through the market open at the start of this week. Already, investors are taking aim at a currency hobbled by a difficult fiscal situation. So long as the Turkey crisis continues to develop, currencies like the Euro (due to European banks' exposure to Turkish borrowers) and the South African (due to its fiscal situation) will see remain pressured - more volatility is ahead.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
To contact Christopher Vecchio, e-mail firstname.lastname@example.org
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