The eyes of the financial world remain firmly on the Turkish lira as it battles to recover from one of the most severe currency sell-offs that the financial markets have witnessed in recent history. The battered lira dropped as much as 20% on Friday August 10 and carried this freefall into Monday 13 August - which at its peak of losses meant that the lira had lost as much as nearly 80% against the dollar year-to-date.
The lira was already undergoing what some would label a currency crisis before the drama unfolded at the end of last week. Although the lira is attempting its third day of gains against the dollar at time of writing, it remains more than 14% lower than before the freefall. My personal expectations remain negative on the lira, but the outlook for other global currencies in the aftermath of the exposure they could have to the Turkey crisis is what we need to monitor.
The lira calamity sent a number of currencies across the globe spiraling lower. Emerging market currencies have been the ones and remain affected the most by the prolonged “risk off” environment in Turkey that prevents investors from taking positions in the emerging markets. As a result of reduced buying demand, a basket of different emerging market currencies globally has suffered losses against the dollar. The Indian rupee has hit an all-time low, the Indonesian rupiah has seen its losses stretch to such an extent that Bank Indonesia have decided to raise interest rates. The Chinese yuan is now at its weakest level since the People’s Bank of China (PBoC) historically weakened the yuan in August 2015 to send the global markets into a selling frenzy, while the South African rand dropped a dramatic 10% early in Asia trade on Monday 13 August as investors refused to take on risky assets. Currency weakness stretched even further than Asia and the EMEA where Latin America FX saw both the Brazilian real and Mexican peso take a hit.
The negative reaction in the euro following the events in Turkey has taken some by surprise, given the political tensions between the European Union and Turkey. But Europe has more exposure to Turkish debt than many realize. Around 20% of Turkish debt is denominated in euros, while an even greater level is as you would expect, denominated in dollars.
The dollar and those currencies pegged to the Greenback have once again found themselves as the “winners” in the latest line of volatility to have braced the financial markets. The Greenback has continued to stretch to new 2018 highs throughout August, with the currency now at its highest level since June 2017. The dollar is up as much as 3% month-to-date, meaning that currencies pegged to the dollar like the dirham (AED) have mirrored this momentum. The dirham has gained close to 5% against the Euro and nearly 10% against the South African rand during this period.
A prolonged “risk-off” sentiment from investors, coupled with continued indications that the United States economy is performing far beyond its developed counterparts, has increased outlook for higher US interest rates. This has also led to expectations that the United States economy will be better prepared to handle the headwinds of a global trade war than the economies it is targeting, leading to the dollar continuing to be in demand from investors.