The TRY is in a full-blown currency crisis as the number of negative stories increases, according to analysts at Nordea Markets.

Key Quotes

“The Turkish lira is in a free fall amid a story from Financial Times this morning that the ECB is concerned about European banks’ exposures towards Turkey (the article mentions explicitly BBVA, Unicredit and BNP Paribas). The lira, which at the time of writing trades around 6.00 against the USD (over 30% YTD, EUR/TRY 6.85), looks broken and has increased contagion risks across the EM market and led to safe haven flows (UST, Bunds and EUR/USD down).”

“The story from Financial Times adds to a number of negative stories about the TRY lately. The fresh negative round of news started when the central bank decided not to hike the interest rates at its monetary policy meeting on 24 July - a big disappointment as the weak TRY increases inflation, which in turns weakens the lira and creates a vicious circle.”

“The market reaction has been strong partly because the central bank decision was probably affected by President Erdogan and the independence of the Turkish central bank is under question.”

“Furthermore, diplomatic tensions between the US and Turkey are increasing as Turkey has refused to free the American priest, Andrew Brunson, who Erdogan claims to be a part of the failed coup attempt in 2016. Consequently, the US has imposed sanctions on Turkey’s Interior Minister and Justice Minister with the possibility of further sanctions on the country.”

“The markets now fear that sanctions could be imposed on Turkish banks. However, we do not consider this as a likely outcome as the US did not impose sanctions on Russian sovereign debt yesterday.”

“In any case, sanctions on the Turkish banking sector would be catastrophic as Turkey is dependent on capital inflows to finance its high current account deficit.”

“Only a small share of the chronic deficit has been financed via foreign direct investment while the majority of financing has come into the country in a more speculative format. In a case of a crisis, this normally implies a lot of volatility and quick capital outflows.”

“Furthermore, a considerable share of external financing is short-term debt. This means that refinancing needs cause a challenge for Turkey very soon in an environment of a weak currency and sanctions could worsen the situation even more.”

“Overall, the central bank’s tools to intervene to the currency market are limited because of the small size of fx reserves compared to the liabilities. The IMF warned about the low relative level of reserves already last spring and reserves have continued to decline since then.”