Emerging markets take a beating as a currency crisis in Turkey weighs on investor appetite, but the episode is also a reminder that Europe’s banking system continues to be seen as a threat to global growth and developed markets.
“The question is whether the massive defaults of Turkish corporate borrowers, with or without a full-blown sovereign debt crisis, will destabilize the already fragile eurozone banking sector,” wrote Carl Weinberg, chief international economist at High Frequency Economics. , in a Monday note. “Euroland banks are so undercapitalised that if hit, they may have to cut lending to stay within regulatory limits.”
The Turkish lira renewed its plunge on Monday, hitting a new all-time low against the US dollar USDTRY,
Turkish authorities have taken steps to boost liquidity, but efforts have not been sufficient to allay concerns about the financial condition of the economy. Other emerging market currencies and assets have been hit hard by fears of ripple effects. The iShares MSCI Emerging Markets EEM ETF,
a popular exchange-traded fund that tracks emerging market stocks, pared its earlier decline but remained at 0.8%, leaving it down 4.5% so far in August and more than 9% since the beginning of the year.
“A credit crunch would send the euro zone economy into a spiral,” Weinberg said.
Lily:Turkish lira crisis sends shockwaves through emerging market funds
Also see:3 Reasons Why Selling Turkish Lira Matters to Markets Around the World
European bank stocks were hit on Friday after the Financial Times reported that European Central Bank regulators were concerned about the exposure of Spain’s BBVA BBVA,
the Italian UniCredit UCG,
and the French BNP Paribas BNP,
to read weakness. The report said regulators do not yet consider the situation critical, but the watchdog is concerned as all three maintain significant operations in Turkey. Specifically, regulators are concerned that Turkish borrowers are not protected against the weak lira and could start defaulting on loans denominated in other strengthening currencies.
The Stoxx Banks Index extended its decline on Friday to around 2% on Monday, leaving it down around 8% so far in August, according to FactSet data. Overall, European stocks were again dragged lower, with the pan-European Stoxx 600 SXXP,
losing 0.2% over the session, while the Italian FTSE MIB I945 index,
lost 0.6% and the Spanish IBEX 35 IBEX index,
US equities had tried to shake off global weakness, with the S&P 500 SPX,
down 0.3% at midday after trading on both sides unchanged during the session. The Turkish situation offered another headwind for the euro EURUSD,
which fell 0.2% against the dollar to trade at $1.1393 in the recent action.
Some economists have argued that total exposure is manageable.
“Of course, investors are also worried about the implications of Turkey’s problems for the banking system and the eurozone economy. But while these concerns add to the long list of recent headwinds for the euro, neither the overall exposure of eurozone banks to Turkey nor the direct links between the region’s economy and the country are important,” said John Higgins, market economist at Capital Économie, in a note.
Others see the potential for significant repercussions.
The falling lira “raises the local currency counterpart of the country’s burgeoning foreign currency debt to unsustainable levels,” said HFE’s Weinberg. “Much of this is due to Eurolanders jumping on Turkish assets for yield.”
The threat, he wrote, is that Turkey’s woes could “spill over and hammer EU institutions.” Cascading problems can transmit instability to EU banks. Uh oh.”
Meanwhile, Turkey’s woes come as concerns over Italy’s sovereign debt and its banking sector returned to headlines.
A continued sell-off in Italian government debt sent the country’s 10-year government bond yield TMBMKIT-10Y,
up more than 10 basis points on Monday at 3.09%, hitting a two-month high. The yield premium demanded by investors to hold the Italian 10-year compared to its German counterpart TMBMKDE-10Y,
widened to more than 280 basis points, or 2.8 percentage points, the highest since late May. A widening gap between the sovereign pair is often seen as a sign of perceived rising concerns over Italy, with Germany, the largest of the eurozone economies, tending to attract investors in quest for security. Bond yields fall as prices rise.
Italy has drawn particular concern from market participants due to its overall debt burden and a recent election that observers worry about the southern European country’s financial health.
The public debt burden of the Italian economy amounts to 133%. Investors remained nervous after the formation of a government last spring led by two populist parties that stoked fears of a fiscal showdown with its eurozone partners. Concerns about Turkey and uncertainty surrounding the Italian government’s economic plans are behind the recent weakness in Italian bonds.
To see:Here’s why Italy and the financial markets are still heading for a showdown
“Our main concern is broader contagion from emerging markets, rather than Turkey in isolation. Yet, it feels like these risks pale next to Italian sovereign risks,” credit analysts at Bank of America Merrill Lynch wrote in a Friday note.