Talking Turkey … and Greece

June 12, 2013

Yesterday was another day of turmoil for emerging markets and according to equity index provider MSCI, they have a new member.

For anyone who thought the euro zone’s debt crisis was over, MSCI lowered Greece to emerging market status last night. MSCI’s focus is the useability of the stock market – which it said fell short of developed market status – but its move casts a wider judgment on an economy still deep in recession, with unemployment at 27 percent and which will almost inevitably need a further debt writedown in the future.

An MSCI upgrade can attract a wider poll of investors who track its indices. The reverse is also true.

Greece’s failure this week to find buyers for its state-owned natural gas company – a key part of the privatisation drive which the EU and IMF demanded as part of its drive to cut debt under a second bailout programme – makes another debt restructuring all the more likely and this time it will be euro zone taxpayers footing the bill since it is their governments that are the creditors. That means there is no chance of it happening this year, with German elections looming, but further out…

There is no sign of calm returning to emerging markets, still spooked by Ben Bernanke’s warning that the Federal Reserve could soon begin to slow the pace at which it creates new money. Much of the $85 billion a month the Fed has magicked up has flooded into those markets offering a decent return and the fear is that if U.S. bond yields rise as one would expect, it will flood out again. The jitters have been exacerbated by the Bank of Japan’s decision this week not to take fresh steps to calm its markets.

Countries with domestic problems to boot, most notably Turkey, have borne the brunt. Turkish riot police fought running battles with pockets of protesters overnight, clearing the central Istanbul square that has been the focus of nearly two weeks of protests against Prime Minister Tayyip Erdogan.

South Africa’s rand hit a four-year low before finding its feet. It has its own problems with the threat of more crippling strikes in the mining sector. Both countries also suffer from gaping current account deficits which render them vulnerable in this sort of climate.

Turkey’s central bank managed to steady the lira yesterday by selling dollars in $50 million chunks through the day. But that’s not a long-term solution. So far, there has been no significant damage to the economy but if the crisis proves to be protracted, that could change.

Erdogan has also spooked investors by threatening to target speculators. That’s probably for domestic consumption but if capital controls or other measures are imposed the market side of this crisis will get a whole lot worse. Credit default swaps have already hit a 10-month high.

Looking through the other end of the lens, we have argued that the Fed may be persuaded not to adjust course if the current turbulence morphs into full-on investor flight from emerging markets, which hold massive amounts of U.S. Treasury bonds as capital insurance buffers. [ID:nL5N0E51N1]

Back to the euro zone, and it’s day two of the German Constitutional Court’s hearing on the European Central Bank’s unused bond-buying programme.

There were some interesting pointers on day one with German finance minister Schaeuble defending the plan and questioning the court’s jurisdiction over an EU institution.

ECB policymaker Joerg Asmussen insisted the scheme – which has dramatically eased the pressure on euro zone strugglers by slashing their borrowing costs – was squarely within the ECB’s mandate while his friend and colleague, Bundesbank chief Jens Weidmann, said the protective umbrella risked lifting the pressure on governments to reform and harming the credibility of monetary policy.

The odds are that Germany’s top court will refer the matter to the European Court of Justice. That, legal experts say, would make an unalloyed judicial blessing for the OMT far more likely.

But there is also the possibility that it could challenge narrower aspects of the programme, such as ECB President Mario Draghi’s insistence that there is no limit to the amount of government bonds that could be bought. Even that would be a bombshell for investors, who would sense – and maybe exploit – a new chink in the euro zone’s armour.

Asmussen addressed that point by saying the programme had to be ostensibly unlimited to convince markets of its power, but that there were in fact limits because the ECB had said it would only buy shorter-dated euro zone bonds and there was by definition a limited stock of them. The court will not rule either way until after German elections in September.

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