The worsening of sentiment Friday spilled over into the early hours of trading today until Turkey’s finance minister promised to announce a plan to address the lira crisis. But the list of options is not attractive and President Erdogan has spoken out against the most effective option, which would be a radical increase of rates.
In a more normal situation, the country’s political leadership would have to admit defeat and appeal to the International Monetary Fund for help, but Erdogan will not reach for this option as he sees it as a loss of credibility.
Other EM currencies with large USD debts in their private sector were also in for a drubbing overnight, particularly the South African rand, which suffered a flash-crash like 10% devaluation overnight before bids came in and reversed.
The contagion from the TRY situation is spreading across all assets and around the world, as even a higher than expected (highest since the global financial crisis) core US CPI print at 2.4% couldn’t keep US treasuries from rallying steeply.
In G10 FX, as the situation worsens, the pattern seems to be that the USD and CHF remain approximately equally strong, while the JPY is stronger still and the euro is divergently weak despite its liquidity due to EU banks’ exposure to Turkish debt.
The single most important factor to watch in the currency space besides the TRY and whether this source of the contagion can be turned, is whether China allows the USDCNY rate, clearly under enormous pressure given what is unfolding, to move beyond 7.00. This could in turn provide additional fuel to the markets’ concerns.
AUDJPY is the classic risk-off pair within G10 and this time is no exception as the pair looks at the big 80 area and therefore the lowest level since late 2016. As market volatility heats up, traders should recognize that it is very difficult to find diversification as correlations quickly head toward 1. So for the short term, AUDJPY will move in synch with EURCHF, EURUSD and NZDUSD in all likelihood until the market’s temperature drops again.