Scores On The Doors

Another leg lower in the Turkish lira overnight, dragging down with it a whole bunch of other EM currencies. Measures announced by the Central Bank stopped the rot briefly, and USD/TRY now sits in the middle of a delightful 6.40-7.20 range. For comparison, in January the entire month’s range was only 3.76-3.95: we have done four times that in less than 24 hours.

The scores on the doors show:

  • Last week was the worst for the Turkish Lira since 23rd February 2001 – which itself came only after the central bank stopped defending the soft lira peg that was put into place after the IMF bailout. Back then, the central bank lost one-sixth of its FX reserves and interest rates hit 3,000%.
  • The sell-off in the South African Rand was the worst since 15th October 2008 – right in the heat of the financial crisis, when USD/ZAR moved from 9.07 to 10.74. Last night was Sunday twilight liquidity but USD/ZAR moved from 14.20 to almost 15.60 and back again

So we are seeing the kinds of moves that accompanied very serious financial market stress – and yet, aside from Turkey’s problems, there really isn’t that much stress around.

In any case, is this really that big of a crisis for an Emerging Market? Bloomberg burbled this chart to claim that no, it’s not:

To which we would respond:

  • August 2018 ain’t over yet folks!
  • Turkey 2001 occurred when a peg was abandoned, yet we have had something similar from a free-floating ccy
  • It’s of a similar magnitude to Russia 1998 which, er, led directly to the LTCM crisis

The last point is the big one. These big moves are happening because of systemic market leverage. The system itself is unstable. Erdogan isn’t to blame for that.

Commentary on Turkey so far simply says:

  • This was obvious; an accident just waiting to happen.
  • Erdogan engineered this, he interfered with the central bank, that’s why it was so bad.
  • Turkey needs this to reverse direction. Markets force change.
  • It’s August so it’s illiquid anyway.
  • …and the impact on other markets should be limited. The ECB is ready to help European banks and they’re already doing QE; the Fed won’t care; the VIX hasn’t budged anyway.

Why don’t we want to see the truth?

  • QE chopped off the downside of any distribution. Passive money removed forward-looking judgment. The future would look like the past.
  • But now QE is stopping. Passive money created a tracking mechanism that falls apart when prices shift dramatically. The future hits us in the face suddenly.

We here at BlondeMoney keep being told that this is all too obvious. That when something happens it will be something unexpected.

We disagree. As we said in Junewe now have Black Swan price action on the evidence of White Swans” and “the real Black Swan will be an event that sends the pendulum into unstoppable overdrive and will be a combination of:
1) positioning and pricing are the exact opposite of where they should be due to a new – or previously ignored – risk
2) flows shift
3) positions tracking passive products like ETFs are forced to liquidate”

Turkey certainly delivered us 2 and a hint of 1 and 3. Here is the iShares Turkey MSCI ETF compared to its “intrinsic value” during the course of Friday:

As you can see there are some large deviations between the two, despite the website for this ETF showing only a Premium of 0.59% “as of August 10”. That’s only derived from its end of day NAV, but as we know the joy of ETFs is that they can be traded intra-day. This one is quoted in USD. But all of its holdings are listed in Turkey.

And that’s before we even go into how on earth an “intrinsic value” can be calculated when liquidity means the price on the screen for stocks or bonds or currencies is not necessarily the price that they can be traded for in reality.

It’s no wonder that we are getting wild price moves when liquidity is so misunderstood. Here’s 1 month USD/TRY implied volatility. It’s now higher than it was during the financial crisis:

We need to look at Turkey with fresh eyes. It’s not about the risk itself, worrying as that might be if you have exposure to Turkey. It is about how a market can spin wildly out of control when the entire system is as unstable as it now is.

We continue to believe that Brexit will be the next big shoe to drop:
1. A previously ignored risk
2. Flows shift – note Financial News reporting today on fund managers triggering contingency plans for a No Deal. ‘Allianz is working out a strategy to ensure it can continue to do business in the UK in the absence of any transitional arrangement. CEO Andreas Uterman said: “I never thought it would come to this”‘
3. Positions

Only 3 is yet to fall into place. We expect that to come in September.

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