KEY INSIGHTS:

  • Turkish crisis: Turkish Lira depreciation in August is the consequence of an unsustainable growth regime financed by rising private debt (mainly external debt), combined with a current account deficit that had become excessively financed by short-term capital flows. In our view, the economy is experiencing a classical balance of payment crisis. Even before the recent crisis, Turkey was the most vulnerable country among the main emerging markets (EM). A mix of monetary policy action, economic adjustments and temporary recourse to some forms of capital control could potentially help to mitigate the crisis, with some de-escalation possible on the geopolitical front between the US and Turkey, but in the short term, volatility will remain high.
  • Contagion risk: While we can see the contagion effects of the Turkish crisis spreading outside the country (for example, through exposure of some European banks or the potential damage of a much stronger USD on other vulnerable EM), we still believe this to be an idiosyncratic event, not a trigger for a wider systemic move, as it mainly reflects the country’s economic fragility and the political backdrop. The impact on the Eurozone economy is expected to be limited. Turkey is crucial regarding the immigration issue: it might even be in the interest of European countries to help Turkey to stabilise its economy.
  • Emerging markets: We are cautious on Turkish assets. The year-to-date selloff makes them attractive in an EM context, but we expect macro fundamentals to deteriorate further and geopolitical issues to continue at least in the short term. We expect countries with strong fundamentals that are less dependent on external borrowing and capital inflows to stay on course. In this environment, we expect divergences to remain in place and eventually to increase, supporting the case for active selection regarding opportunities in volatile markets.
  • Multi-asset: The current turbulence may increase the vulnerability of the developed markets (DM) credit, on which we were already cautious, but the still-positive growth and the solid outlook for corporate earnings should prevent an extended risk-off mode. Consequently, we don’t expect DM central banks (CB) to change their policy strategies in response to the current turbulence. Overall, we have gradually reduced our preference for risky assets through the year, as the global economy transitions to a more mature phase of the cycle. This allows us to navigate phases of increased volatility and scarce market liquidity with a lower directional exposure.