13 to 19 August: Turkey is idiosyncratic, not systemic

Headlines were dominated by the market turmoil in Turkey that triggered a mini meltdown in the EM universe. With a few exceptions, all emerging and frontier markets were hit during the week. Consequently, the MSCI Emerging Markets index closed 3.71% lower in USD terms. Recent market movements have been excessive and fundamentally not justified, in our opinion, as most of the emerging and frontier markets do not exhibit such vulnerabilities and idiosyncratic risks as Turkey. The few economies that bear some resemblance to Turkey, such as Argentina, stand ready to deliver appropriate policy responses to curb capital outflow and reduce asset price volatility. Furthermore, there are no significant channels of contagion through the real economy, neither direct or indirect, as the trade linkages between Turkey and other EM countries are rather weak. Although financial linkages between Turkey and the rest of the EM universe are negligible, elevated asset price volatility and excessive capital outflows can sometimes have unintended consequences, such as a sudden changes in the course of monetary policy or an otherwise unexpected downgrade.

Due to the sentiment-driven nature of the recent market mini meltdown, EM indices are likely to bounce back once the risk-averse mood fades. The timing of the rebound depends only on when the US administration deals its finishing blow, as market players wants to see what price a disobedient country pays when it openly rebels against the wishes of the POTUS. We are of the view that the global growth story has not been hurt because of the Turkish demise, and once the horizon clears, EM and FM markets will benefit from a restoration of global risk appetite.

Looking ahead

Since the economic calendar is rather light on macroeconomic data releases this week, markets will focus on developments in Turkey, the trade talks between the US and China, the content and tone of the Federal Reserve’s minutes and speeches delivered by central bankers in the Fed’s annual symposium in Jackson Hole starting on Friday.

The Fed’s minutes from the last rate setting meeting should reaffirm that the FOMC will deliver two more 25bp rate hikes this year, as the Committee’s reaction function overweights underlying economic developments within the domestic US economy relative to external noise, such as Turkey. Chair Powell may reflect on this idea in his speech in Jackson Hole. Markets will have to find comfort in the idea that Turkey is an insulated idiosyncratic story that has little chance to be contagious.

In Asia, Taiwanese unemployment and industrial production and Malaysian CPI inflation releases will be published. In Latin America, Chile, Peru and Mexico will release 2018 Q2 GDP data. In addition, the Argentinian trade balance and economic activity index and Mexico’s CPI inflation and current account balance can influence local market sentiment. In Africa, South Africa will reveal CPI inflation.

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