Erdogan Signals A Lot More Pain Ahead For Turkey

It seems that rather than offer any orthodox policy solutions, Turkish President Erdogan is doubling down on his confrontational stance. This spells more trouble for Turkish markets when they open Monday. The rumored emergency meeting between Turkish regulators and banks did not materialize this weekend.  As usual, Erdogan railed against higher interest rates, claiming they make the rich richer and the poor poorer. He pledged that while he remains alive, Turkey won’t fall for the “interest trap.” Erdogan played the victim card, saying that the financial stresses are another attack on him, like the attempted coup. Erdogan said that those calling for IMF aid want Turkey to give up its independence.

In terms of FX, Erdogan repeated his call for Turks to convert their holdings into liras. He defiantly said that it’s foolish to think that Turkey will stumble because of FX markets. Erdogan said that he’s ready to respond with new financial tools against the dollar.

In terms of international relations, Erdogan said that “the US is attempting to sacrifice an ally of 81 mln for a pastor.” He said that the responsibility for poor relations lies with the US. He added that Turkey is looking new markets and alliances.

This is all vintage Erdogan. Whilst it might play well on the campaign trail, this is not what markets want to hear right now. Policymaking in Turkey remains top-heavy and run by Erdogan. Market-friendly officials have been eliminated from the cabinet or marginalized.

With Erdogan signaling no policy changes yet, we expect USD/TRY to easily make new all-time highs above the one from Friday near 6.87. 10-year local currency government bond yields cracked 20% Friday, and are also likely to march higher in lockstep with the weaker lira. With a hard landing for the economy becoming increasingly likely, Turkish equities should continue to sink.

In related news, economics Professor Steve Hanke came out over the weekend and said Turkey should adopt a gold-backed currency board. This is not the solution, as Turkey’s problems are much too complex and wide-ranging. As the saying goes, “When the only tool you have is a hammer, every problem looks like a nail.”

Bottom line: Turkey has not yet reached its pain threshold whereby it will shift to a more orthodox policy stance. That means things will get much worse before they get better. But make no mistake, Turkey is in for some serious pain. We will put out a longer piece on Monday that focuses on the likely outcomes ahead, based on past crises we’ve seen in Turkey. If it keeps going down its current path, Turkey (and the market) has to be prepared for a hard landing, corporate defaults, and bank failures.

Markets are on heightened alert for contagion, but we continue to downplay this notion in favor of one that recognizes that EM is in a broad-based bear market. As such, we see continued underperformance by TRY, ARS, RUB, ZAR, and BRL due to idiosyncratic risk in these countries.