Trader thoughts - the long and short of it

While the weakness in the Turkish economy has been anything but a secret, the ECB’s admission that it is concerned about the health of the region’s financial system sent traders scrambling for the sell button. Japanese equities were the first to wear the brunt of the panic, closing 1.3 per cent lower, before European and US markets followed suit, led lower by falls in financial and industrial stocks. The frenetic end to the week establishes a shaky lead for traders today, who will have to price another global financial risk into markets.

Turkey: Turkey’s problems are worth summarising, particularly given they are shares by many emerging markets at present. The Turkish economy has come under significant pressure recently owing to a combination of high debt levels, tighter global monetary conditions, and the recent imposition of tariffs slapped on the country by the Trump administration in response to the jailing of an American pastor in Turkey. These variables have compounded to spark a flight of capital out of Turkey, which has sent the Turkish Lira tumbling to all-time lows. The reports regarding the ECB’s fears about Europe’s exposure to Turkey’s financial markets accelerated the Lira’s plunge, raising the question as to whether Turkey’s problems could soon become the world’s problems.

Contagion: But why and how could an emerging economy like Turkey, and its struggling currency, become such a big issue for the global economy? The word that will keep coming up for as long this issue is in the headlines is “contagion”. Just as many other countries have in the years following the GFC, Turkey has gorged itself on cheap debt. As the US economy booms and the US Federal Reserve pushes US (and therefore global) interest rates higher, the cost of servicing debt becomes far more onerous. Not only that, but higher US interest rates makes risk taking — like investing in or holding assets in emerging markets such as Turkey — less attractive, pushing money flows out of those assets and into safer and relatively higher ones in the US denominated dollars.

The selling of out of Turkish capital markets means a selling of the Turkish currency, depreciating the Turkish Lira and increasing in relative terms the cost of servicing foreign debt - most of which is increasingly expensive US Dollars. The ultimate fear is that this debt blow-out will result in a wave of defaults, first in Turkey, then Europe (as highlighted by the ECB last week), then across the world, and will ultimately culminate in strangling of credit markets and therefore a squeeze on the global economy.

ASX: SPI futures are remarkably pointing to a higher open for the ASX 200 this morning after the local market shed 0.3 per cent on Friday to close at 6278. Even before the news broke about Turkey’s troubles, it was proving to be a lukewarm day for Australian shares: a pullback in commodity prices was stifling trade in materials stocks, while a modest push higher in the financials were keeping the overall index only slightly below the day’s opening price. It was a minor sell-off in financial stocks in the final hours of trade that, prompted by fears of global financial contagion, dragged the ASX lower and away from testing new highs above 6300. Although futures are indicating a positive open for the market today, it is difficult to imagine that a concerted move higher in the ASX is possible while commodity prices remain under pressure and fears persist about global financial stability.

US CPI: Before the debacle that has befallen Turkey and therefore global financial markets occurred, Friday’s release of US CPI was tipped to be the headline event for the week. The outcome is one that should be noted, with headline US consumer inflation showing a slight uptick last month, climbing to 2.9 per cent on an annualised basis. The result affirms that the US economy is really picking up steam now, vindicating the view that US interest rates need to move higher to contain economic activity. The US Dollar picked up off the back the news, adding to the gains attained following a risk-off play after the kick-off of the Turkish crisis, with the greenback floating around the 1.14 handle against the EUR and currently trading at .7275 against the AUD.

UK GDP: UK GDP data was also released on Friday night, printing mixed results, revealing that the British economy expanded by a better than expected 0.4 per cent for the quarter, but a lower than expected 0.1 per cent for the month. In what may tip the overall assessment of the data into negative favour, the details of the GDP figures showed that consumption has slowed within the UK economy, likely owing to a fall in consumer confidence as bedevilled Brexit negotiations play out. The GBP/USD continued its plunge on the back of the news, losing its footing around the 1.28 handle to stumble to 1.2752 at time of writing.

RBA: In news of domestic significance, the RBA released its quarterly Monetary Policy Statement on Friday morning, capping off a busy week for Australian Monetary Policy buffs. The RBA extended its rosy assessment of the Australian economy, highlighting strong local and global growth prospects while touching on the risks of high debt levels domestically and geopolitical risks internationally. The major takeaway from the RBA’s comprehensive report was the central bank’s implication that its employment and inflation targets may take longer to achieve, effectively stating that they would not be achieved at this stage until early 2020. Reactions in financial markets were rather subdued, as it appeared the central bank’s forecasts were falling into the line with the markets preconceptions about interest rate conditions.