The fundamentals for the Turkish economy are pretty weak. Strong growth has been secured at the expense of high inflation, a balance of payments deficit and high external dollar borrowing. With interest rates, already well into double figures, markets were calling for short interest rates to rise into the mid twenties to combat inflation and stabilize the currency.
The Trump tariffs were the trigger for collapse in the Lira. The currency fell by 20% against the Dollar last week. Contagion fears pushed markets lower in Europe and the UK. Stocks fell in China, Hong Kong and Japan as fears of trade wars increased.
Emerging markets came under pressure. Currencies in Argentina, South Africa, Thailand and even India came under threat as sentiment flowed in favour of Uncle Sam and the currency of choice. It's all about the Dollar. The Fed plans further rate hikes this year on the back of strong growth and rising inflation.
The impact of the tariffs were slightly irrelevant. Turkey exports just $1.5 billion in metals to the USA. The geo political significance of the move was more significant. The US is prepared to move against an ally on the strength of a whim from the White House. Turkey is planning to buy the S-400 missile defence system from Moscow. Trump threatened to pull the sale of US F-35s to Turkey. Does that make sense? Not really.
Trump is upset. "Turkey has taken advantage of the United States for many years." he tweeted. "They are now holding our wonderful Christian Pastor hostage. We are cutting back on Turkey!".
The message to friend and foe alike is evident. Strategic partnerships do not from part of Trump diplomacy. There is no think through on actions taken. Russia interests will be strengthened in Eastern Europe. China's interests will be accelerated around the world. Membership of NATO will no longer make much sense to the buffer state. Russia and China were quick to offer support both in terms of trade and finance to Ankara.
As for contagion, the real threat of spread is limited. This is not a prelude to the financial collapse of 2008, nor is it likely to be as significant as the "taper tantrum" of 2013. Emerging markets are in better shape, with lower inflation, higher foreign reserves and flexible exchange rates. With the exception of Argentina perhaps, the major problems are unique to Turkey.
The Turkish economy grew by over 7% in the first half of the year. Inflation hit 16% in July. A rising balance of payments deficit funded by dollar borrowing led to a hike in risk spreads on the currency. Trump's tariffs were the catalyst for the Lira collapse not the cause. Should we be worried? Not really
It is August, most traders are away on holiday. Those at their desks will delight in Turkish turmoil for now. The fundamentals remain strong for the world economy. Once the mid terms are out of the way, we expect peace to break out amongst the threat of trade wars. Making America Great Again will become the priority. It will not be achieved by punitive tariffs and sanctions often in contradiction of American interests ...
Back in the UK ...
Inflation increased to 2.5% CPI basis in July. Goods and Service sector inflation were unchanged at 2.6% and 2.3% respectively from prior month. The headline marker should probably have increased in June.
Weaker currency and a recovery in oil prices largely to blame, we expect inflation to remain above target for the rest of the year closing around 2.4%.
Producer prices increased by just 3.1% in July. Input costs on the other hand, increased by almost 11%. Oil, fuel and imported metal costs largely to blame for the hike. It's a familiar story. Rising oil prices and a currency under pressure lead to higher domestic prices and a real household income squeeze. Manufacturing margins will be inhibited as output remains flat. Manufacturing output in the second quarter was up by just 1.5%.
"Manufacturing Margins Under Pressure"
News from the retail sector was more upbeat. The volume of retail sales increased by 3.5% in July. The value of sales increased by almost 6%. So much for a squeeze on spending. Online sales increased by 15% now accounting for over 18% of retail sales. The squeeze on traditional retail continues, placing further pressure on high street structures.
Job news was also good this week. Unemployment levels fell to 1.36 million in June. The unemployment rate fell to 4.0%. The number of vacancies increased to a record high of 828,000. Recruitment difficulties are increasing. So what happened to pay?
The low pay anomaly continues. Despite the strong jobs market, whole economy earnings fell to 2.4% in June. Construction pay increased by 5%. Our "brickies" index is going through the roof!
Need more information? Check out the Monthly Round Up on the Saturday Economist Web Site. Here we provide more detail on monthly data with some great charts and forecasts, you can copy and use at will ...
Don't Miss Our Monday Morning Markets ...
Don't forget! Monday Morning Markets is back. The update is released every Monday Morning at around 8:00am.
We look at key stock markets, bond markets, interest rates and currencies every week and monitor trends and direction in key areas.
Last week our "Empires of the Cloud" fund took a hit. We moved into China taking a hit on the index and our online pair of BAIDU and Alibaba. We are still in profit thanks to a great performance in Apple, Square and Twitter. Our index tracker fund shows the damage from the "Turkish Turmoil". Much red in Europe and South East Asia led to an overall loss of just over 1% in the week. We expect a big rally in the return to work phase ... coming soon!
That's all for this week, we will be back next week, with more economics. and markets.
Have a great weekend,
The Saturday Economist
John Ashcroft publishes the Saturday Economist. Join the mailing list for updates on the UK and World Economy.
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The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The presentation should not be construed as the giving of investment advice.