Should the recent financial turmoil in Turkey be considered an isolated event or is it one of those financial canaries in a coal mine? On the one hand, it is clear that local policy and president Erdoğan’s bellicose handling of foreign relations have both contributed to the slide in Turkish assets. Those who believe such factors have been the main driver of the sell-off argue that Turkey is going bust for idiosyncratic reasons, and so maintain that a relatively risk-on stance is appropriate.
To us, there is little doubt that the protracted nature of Turkey’s bubble has ensured a deep structural maladjustment, misallocated capital and financial excesses. The risk is that, should the market continue to command higher yields on Turkish assets in order to provide compensation for increased risks, those financial excesses may prove unsustainable. Should Erdoğan adopt a more market-friendly approach to international relations and a more orthodox approach to domestic fiscal policy, perhaps Turkish yields will decline to a level where financing costs are consistent with sustaining the status quo.
However, the other school of thought is to view Turkey as merely the symptom of a wider liquidity malaise globally. The evidence increasingly suggests that the environment of self-reinforcing expanding liquidity, indiscriminate buying of financial assets (speculation) and rising asset prices/bullish trends has come to an end. In this context, declines in Turkish asset prices are met with selling rather than being regarded by many as a dip to be bought. Moreover, while Turkey is the most conspicuous example of this pattern to date, we believe it is one that is becoming increasingly widespread, marking a departure from market dynamics in 2017.
Brendan Mulhern, global strategist. Newton Investment Management, a BNY Mellon company