The developing world seems to be on unstable ground of late, bringing sharp losses across stocks and (most noticeably) currencies. For many it is a red flag that we are seeing so many apparently independent crises happening within such close proximity of each other. The most recent of these has occurred in Argentina, where the government is under pressure to fix an ailing economy which has a host of issues pushing investors out of the country. These three examples provide a range of circumstances, yet one recurring issue is related to the exchange rate. With the dollar appreciation over the past six months, there was always going to be a fear that those developing economies with high dollar denominated debt were going to be exposed.
Certainly one of the most impressive declines seen in the emerging market (EM) space of late has come from Turkey, with the lira losing 65% against the dollar in the past four months. This has been associated with a host of issues within the country, both political and economic. Attempts to arrest the decline in the lira have largely been unsuccessful, with the current 17.75% headline interest rates perceived as too low by markets. This week’s announcement that the central bank will provide its independence has raised expectations of a rate hike, despite President Erdogan’s aversion to the tool. The decline in the lira may be partly due to Turkey-specific issues, yet there has certainly been a response throughout the EM space.
One issue that appears to be a key element for all of these nations is inflation, with the fall in a currency raising the cost of imports, thus leading to imported inflation. This adds to the sense of crisis, with the radical shift in prices sharply hitting the economy as wages fail to keep up. This fall in real income means that consumers are typically unable to maintain their previous purchase capacity, thus reducing demand and hitting the economy. However, the tool traditionally utilised by central banks to arrest a rise in inflation is an interest rate hike. Unfortunately, this raises everyday costs (such as mortgages) and deters investment/borrowing. Thus, the solution to these issues will typically drive further contraction in the economy. This is a vicious spiral and can be difficult to halt.
The lira certainly has taken a beating, and with USD/TRY attempting to hit the 71,151 highs once again, we could be set for another push from here. However, the ability to break that level is going to be crucial as there is a chance of stabilisation following recent volatility. Thus it makes sense to await a break through resistance to look for further upside, where intraday bearish signals could provide a sign that we are set for a period of wide consolidation.
