There Are No Coincidences: Turkey Fires Warning Shot to Global Markets

Back in 2015, I posted Geopolitical Forecasting Through Technical Analysis: Is Turkey About to Destabilize the Middle East?. I saw a topping pattern with a very low potential target. Combined with domestic politics, economy and regional instability, it looked like the stars were aligning for a very negative outcome.

All of which is to say, I can see the Turkey ETF (TUR) hitting single digits solely through currency depreciation and financial crisis. There's enough fuel there for it. However, geopolitical developments concern because they are likely to deteriorate along with the economy. If the chart is correct, economics and politics are going to get much worse for Turkey in the months ahead. Of course, the chart might reverse and the pattern may break, making a short of TUR a bad trade and a forecast of instability a wrong one. If it doesn't, Turkey may quickly become the new center of attention in the Middle East.

It took longer than I expected. The deterioration was slower, and then now it is going all at once. The credit bubble kept expanding, Erdogan's accumulation of power didn't create extreme damage right away. The Trump administration did not reorient foreign policy in the Middle East and the EU ruling class enabled the migration crisis instead of confronting it, both of which delayed a potential break with Turkey.

Back then I was look at this topping pattern.

I said the target was the single digits. The chart hasn't made it that far yet, but support right now is around $16.50 and below that there is the 2008 low around $13 per share.

The best way to play Turkey's collapse was not the stock market, but the currency:

Reuters: Lira collapse leaves Turks bewildered, opposition angry

Anxious Turks struggled to keep up with a bewildering collapse in their currency and the main opposition party leader said the country was experiencing its darkest "catastrophe" as the lira slumped 15% on Tuesday against the dollar.

Tuesday's meltdown follows weeks of steep falls in the lira which have already driven up prices, leaving ordinary Turks reconsidering everything from their holiday plans to weekly grocery shopping.

"There has not been such a catastrophe in the history of the Republic," said Kemal Kilicdaroglu, leader of the opposition Republican People's Party, blaming the currency freefall on President Tayyip Erdogan who has led the country since 2003.

"At this point, you are a fundamental national security problem for the Republic of Turkey," Kilicdaroglu said.

The collapse in Turkey's currency is a geopolitical problem. As the largest economy in the Middle East with ties to European banks, and as a key player in regional security, the fallout from the collapsing lira hasn't really hit the region yet. But it will.

European banks have been lightening exposure to Turkey over the years. European banks feel the heat as Turkey's currency plunges

Shares in Spain's BBVA (BBVA.MC) fell 1.2%, to a two-month low, with the bank seen as the most exposed to Turkey.

BNP Paribas (BNPP.PA) of France and Dutch bank ING Groep (INGA.AS) also do business in Turkey and may be hit by a slump in its currency. Italy's UniCredit (CRDI.MI) is in the process of exiting the country. Spanish banks have by far the largest loan exposure to Turkey among Western lenders at nearly $63 billion, followed by banks in France, Germany, Britain, United States, Japan and Italy, data from the Bank for International Settlements (BIS) shows.

Europe has its own problems besides Turkey. Here's a thinly traded ETF of European financials. It looks ready for another vertical move lower.

I still believe Turkey will eventually be kicked out of or leave the EU and NATO, should NATO continue to exist at all. The exit by European banks is one piece of a big puzzle that will eventually erode support for Turkey on the continent. If I am wrong, perhaps there are enough Kemalists left who will turn the country back towards the West. As the country destabilizes, prediction become more difficult because the probability of outlier events rises.

For global markets, the collapse of the lira seems far away because it doesn't immediately impact on global markets. However, the question must be asked: why now? Turkey has been doing the same things for years, why did the lira collapse now? Perhaps it is global pressures that pushed Turkey over the edge again. Central planning looks good when times are good. Global and even local macroeconomic forces can overcome bad policy for years on end. Every commodity cycle, there are examples of a resource boom overcoming all but the worst governments. When the positive external forces reverse, then the reality of the underlying economic destruction is revealed all at once. It is no different with Madoff and Enron. As long as the prices that mattered were rising, no one was the wiser. Only a few prescient analysts who dug into the numbers were aware of the real weakness.

Let's look to the past for Turkey. The last time the Turkish lira experienced a collapse similar to the current one was in 2018. On the chart above, USDTRY climbs into the rainbow for the first time. The vertical move was a four- or five-month affair depending on where you mark the start of the move. The lira bottomed out (USDTRY topped in the chart) in August 2018. Back then the Chinese economy was slowing, the global economy was slowing, the Federal Reserve was tightening with QT, the U.S. dollar was rising and then global markets began selling off in late September. Here is the euro to give evidence of the stronger dollar: