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August has been an ugly month. Look around the world and most assets are suffering as the lagged reality of shrinking central bank balance sheets and a Fed-enabled dollar-shortage has sparked a renewed anxiety the likes of which we have not seen for a decade. There’s just one thing – despite all this turmoil, US stocks remain the cleanest dirty shirt as investor ignorance or faith continues to beggar belief.

David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates, feels the same way – questioning market participants’ cognitive dissonance: “The ‘Shining City on the Hill’ so far this month has seen eight economic data releases miss, three beat and one come in as expected. Nice start to Q3.“

The ‘Shining City on the Hill’ so far this month has seen eight economic data releases miss, three beat and one come in as expected. Nice start to Q3.

— David Rosenberg (@EconguyRosie) August 16, 2018

Visually it is easy – US Macro data plunged to 11-month lows today as US equities remain somewhat bulletproof…

A look around the world and it’s clear that the fecal matter is starting to hit the rotating objects in almost every asset class and geography. As Rosenberg exclaimed last week, “The only folks that can’t see it in the FX and commodity markets spend too much of their day gazing at the SPX and Russell 2000. There is no decoupling, just lags.”

No contagion, eh? The only folks that can’t see it in the FX and commodity markets spend too much of their day gazing at the SPX and Russell 2000. There is no decoupling, just lags. pic.twitter.com/521jXi9BiE

— David Rosenberg (@EconguyRosie) August 15, 2018

And as the chart below shows – with central bank balance sheets now contracting, ‘risk-on’ trades are being collaterally-damaged as dollar tightness spreads (except in US equities)

But amid all this US equity market euphoria, Rosenberg asks (and answers)- “Is the stock market flashing an anti-growth signal?”

Simply put, recent market strength is being driven by the S&P 500 Index’s industry groups that are least affected by slower economic growth.

An index tracking four defensive areas – consumer staples, health care, telecom and utilities – climbed 10.3% in the three months ended Thursday. A similar gauge of economically sensitive groups – consumer discretionary, energy, industrials and raw materials – gained just 0.5%.

With the incessant flattening of the US Treasury yield curve standing in direct opposition to the rise in US equity indices, Rosenberg concludes, “I’m asked what the Treasury market sees that the stock market doesn’t.”

His answer explains it all (now that the chart above has exposed reality):

“They both see the same thing – a return to stall-speed growth. Look at how the cyclical stocks are faring against the defensives, like Consumer Staples vs Discretionary. Not exactly the prettiest of pictures…”

Trade Accordingly.

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Authored by James Howard Kunstler via Kunstler.com,

The faction that used to be the Democratic party can be described with some precision these days as a three-headed monster driving the nation toward danger, darkness, and incoherence.

Anyone interested in defending what remains of the sane center of American politics take heed:

The first head is the one infected with the toxic shock of losing the 2016 election. The illness took hold during the campaign that year when the bureaucracy under President Obama sent its lymphocytes and microphages in the “intel community” — especially the leadership of the FBI — to attack the perceived disease that the election of Donald Trump represented. The “doctors” of this Deep State diagnosed the condition as “Russian collusion.” An overdue second opinion by doctors outside the Deep State adduced later that the malady was actually an auto-immune disease.

The agents actually threatening the health of the state came from the intel community itself: Mr. Brennan, Mr. Clapper, Mr. Comey, Mr. Strzok, Mr. McCabe, Mr. Ohr, Ms. Yates. Ms. Page, et. al. who colluded with pathogens in the DNC, the Hillary campaign, and the British intel service to chew up and spit out Mr. Trump as expeditiously as possible. With the disease now revealed by hard evidence, the chief surgeon called into the case, Robert Mueller, is left looking ridiculous — and perhaps subject to malpractice charges — for trying to remove an appendix-like organ called the Manifort from the body politic instead of attending to the cancerous mess all around him. Meanwhile, the Deep State can’t stop running its mouth — The New York Times, CNN, WashPo, et al — in an evermore hysterical reaction to the truth of the matter: the Deep State itself colluded with Russia (and perhaps hates itself for it, a sure recipe for mental illness).

The second head of this monster is a matrix of sinister interests seeking to incite conflict with Russia in order to support arms manufacturers, black box “security” companies, congressmen-on-the-take, and an army of obscenely-rewarded Washington lobbyists in concert with the military and a rabid neocon intellectual think-tank camp wishing to replay the cold war and perhaps even turn up the temperature with some nuclear fire. They are apparently in deep confab with the first head and its Russia collusion storyline. Note all the current talk about Russia already meddling in the 2018 midterm election, a full-fledged pathogenic hallucination.

This second head functions by way of a displacement-projection dynamic. We hold war games on the Russian border and accuse them of “aggression.” We engineer and pay for a coup against the elected government of Ukraine, and accuse Russia of aggression. We bust up one nation after another in Middle East and complain indignantly when Russia acts to keep Syria from becoming the latest failed state. We disrupt the Russian economy with sanctions, and the Russian banking system with a cut-off of SWIFT international currency clearing privileges, and accuse them of aggression. This mode of behavior used to be known as “poking the bear,” a foolish and hazardous endeavor. The sane center never would have stood for this arrant recklessness. The world community is not fooled, though. More and more, they recognize the USA as a national borderline personality, capable of any monstrous act.

The third head of this monster is the one aflame with identity politics. It arises from a crypto-gnostic wish to change human nature to escape the woes and sorrows of the human condition — for example, the terrible tensions of sexuality. Hence, the multiplication of new sexual categories as a work-around for the fundamental terrors of human reproduction as represented by the differences between men and women. Those differences must be abolished, and replaced with chimeras that enable a childish game of pretend, men pretending to be women and vice-versa in one way or another: LBGTQetc. Anything BUT the dreaded “cis-hetero” purgatory of men and women acting like men and women. The horror….

Its companion is the race hustle and its multicultural operating system. The objective has become transparent over the past year, with rising calls to punish white people for the supposed “privilege” of being Caucasian and pay “reparations” in one way or another to underprivileged  “people of color.” This comes partly from the infantile refusal to understand that life is difficult for everybody, and that the woes and sorrows of being in this world require fortitude and intelligence to get through — with the final reward being absolutely the same for everybody.

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US equity markets are jumping to the highs of the day after the Wall Street Journal reports  that Chinese and U.S. negotiators are drawing a road map for talks to end trade deadlock, culminating with meetings between U.S. President Trump and Chinese President Xi Jinping at multilateral summits in November, citing officials in both nations.

 

The algos immediate reaction was simple – BTFD…

 

 

 

 

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Google employees have issued a “code yellow” alert to company executives over brewing opposition to a planned censored search engine in China, citing “urgent moral and ethical issues” in a letter circulated internally, reports The Intercept. 

Staff inside the internet giant’s offices have agreed that the censorship project raises “urgent moral and ethical issues” and have circulated a letter saying so, and calling on bosses to disclose more about the company’s work in China, which they say is shrouded in too much secrecy, according to three sources with knowledge of the matter. –The Intercept

The last time Google employees revolted, the company abandoned its controversial AI-drone initiative known as “Project Maven” after around a dozen employees quit and close to 4,000 signed a petition. Many of the same people who led the last effort are now involved in the China protest. 

The China search engine project, revealed earlier this month by The Intercept from leaked documents, would “blacklist sensitive queries” so that “no results will be shown” when people enter certain words or phrases. Code-named “Dragonfly,” the censorship plan was not widely known within Google – relegated to just a few hundred of the Mountain View, CA company’s 88,000 employees. After The Intercept‘s August 1 article, however, angry employees were triggered into an uproar, leading to the “code yellow” situation. 

Now, a letter has been circulated among staff calling for Google’s leadership to recognize that there is a “code yellow” situation – a kind of internal alert that signifies a crisis is unfolding. The letter suggests that the Dragonfly initiative violates an internal Google artificial intelligence ethical code, which says that the company will not build or deploy technologies “whose purpose contravenes widely accepted principles of international law and human rights.” –The Intercept

The letter reads in part: “Currently we do not have the information required to make ethically-informed decisions about our work, our projects, and our employment. That the decision to build Dragonfly was made in secret, and progressed with the [artificial intelligence] Principles in place, makes clear that the Principles alone are not enough. We urgently need more transparency, a seat at the table, and a commitment to clear and open processes: Google employees need to know what we’re building.”

The enraged employees are demanding “an ethics review that includes rank and file employee representatives,” as well as the appointment of an ombudsperson to represent them, and a general call for more transparency.

Many Google employees are members of the Association of Computing Machinery, the world’s largest organization for computing professionals. The ACM’s ethical code states that its members should “take action to avoid creating systems or technologies that disenfranchise or oppress people” and “use their skills for the benefit of society.” Two Google sources told The Intercept that they felt the Dragonfly project clearly violated the ACM’s code of ethics, which has led them to support the protests inside the company against the planned China censorship. –The Intercept

According to sources, Google executives still haven’t broached the subject of Dragonfly with employees – while the company also hasn’t addressed it with the press, saying that it won’t comment on “speculation about future plans.” 

This non-answer has only fueled more anger within the company – with some employees questioning their managers, only to be frustrated from a lack of information. At least one employee who worked on Dragonfly quit the company partly over concerns about the project. Another employee has refused to work on it. 

Earlier this week, hundreds of Google employees shared an essay authored by former Google engineer Brandon Downey, who claims to have worked on an earlier iteration of the censored Chiense search engine in 2006, which was deployed for around four years before the search giant pulled the project over Chinese government efforts to limit free speech and other issues. 

“I want to say I’m sorry for helping to do this,” Downey wrote. “I don’t know how much this contributed to strengthening political support for the censorship regime in [China], but it was wrong. It did nothing but benefit me and my career, and so it fits the classic definition of morally heedless behavior: I got things and in return it probably made some other people’s life worse.”

“We have a responsibility to the world our technology enables,” Downey adds. “If we build a tool and give it to people who are hurting other people with it, it is our job to try to stop it, or at least, not help it. Technology can of course be a force for good, but it’s not a magic bullet – it’s more like a laser and it’s up to us what we focus it on. What we can’t do is just collaborate, and assume it will have a happy ending.”

Meanwhile, a bipartisan group of six US senators and various human rights groups, including Amnesty International, have condemned the Dragonfly project. 

Human Rights Watch senior research Cynthia Wong told The Intercept that Google “owes the Chinese people an explanation of how the firm can launch Dragonfly without being conscripted into human rights abuses.”

“Google earned a lot of good will from the human rights community with it stopped censoring search in 2010. Yet the human rights situation has only deteriorated in the years since. If it re-enters now without any clear strategy as to how its services will improve human rights, it would be a victory for [President] Xi Jinping’s regime and will only serve to legitimize the government’s abusive approach. We haven’t yet heard any such strategy,” Wong added. 

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Authored by Mohamed El-Erian via Project Syndicate,

Rather than sticking with the approach taken by numerous other countries – including Argentina earlier this year – by raising interest rates and seeking some form of IMF support, Turkey has shunned both in a very public manner. Unless it changes course, the government risks much wider damage – and not just in Turkey.

Whether by accident or design, Turkey is trying to rewrite the chapter on crisis management in the emerging-market playbook. Rather than opting for interest-rate hikes and an external funding anchor to support domestic policy adjustments, the government has adopted a mix of less direct and more partial measures – and this at a time when Turkey is in the midst of an escalating tariff tit-for-tat with the United States, as well as operating in a more fluid global economy. How all this plays out is important not only for Turkey, but also for other emerging economies that already have had to cope with waves of financial contagion.

The initial phases of Turkey’s crisis were a replay of past emerging-market currency crises. A mix of domestic and external events – an over-stretched credit-led growth strategy; concerns about the central bank’s policy autonomy and effectiveness; and a less hospitable global liquidity environment, owing in part to rising US interest rates – destabilized the foreign-exchange market.

A political spat with the US accelerated the run on the Turkish lira by fueling a self-reinforcing dynamic. And all of this occurred in the context of a more uncertain and – aside from the US – weakening global economy.

In keeping with the traditional emerging-market-crisis script, Turkey’s currency crisis spilled over onto other emerging economies. As is typically the case, the first wave of contagion was technical in nature, driven mainly by generalized outflows from Turkey’s currency and bond markets. The longer this contagion continues, the greater the concern that it will lead to more disruptive financial and economic outcomes. As such, central banks in several emerging economies – as diverse as Argentina, Hong Kong, and Indonesia – felt compelled to take counter-measures.

What has followed is what makes this episode of emerging-market crisis different, at least so far. Rather than sticking with the approach taken by numerous other countries – including Argentina earlier this year – by raising interest rates and seeking some form of support from the International Monetary Fund, Turkey has shunned both in a very public manner, including through strident remarks by President Recep Tayyip Erdoğan.

Facing an accelerated exchange-rate depreciation that, at one stage, almost halved the lira’s value, Turkey has taken a variety of measures that attempt to simulate – albeit partially – the traditional approach that emerging economies have tended to follow in the past.

Domestically, it tightened funding conditions and, at the same time, provided liquidity to domestic banks, along with regulatory forbearance. It made it harder for foreigners to access lira liquidity, thereby squeezing speculators that had shorted the currency. It promised to deal with credit and fiscal excesses while ruling out capital controls. Externally, the government has mobilized at least $15 billion from Qatar to be used for direct investment in Turkey. And, in the midst of all this, the government also found time to retaliate against the doubling of tariffs on Turkish metal exports by US President Donald Trump’s administration.

The question is whether this response will be enough to act as a circuit breaker, thus giving the Turkish economy and its financial system time to regain their footing. This is particularly important because continued currency turmoil would tip the economy into recession, raise inflation, stress the banking system, and increase corporate bankruptcies.

With this comes the toughest question of all for the government: Can it bring about recovery without reneging on its pledge not to raise interest rates or approach the IMF? It is possible, but not probable.

Absent additional measures, it is unlikely that a critical mass of corrective steps has been attained in Turkey. While the domestic policy adjustments provide short-term relief for the currency, they may be neither comprehensive nor sufficient as yet to return Turkey to a promising path for inclusive economic growth and durable financial stability.

On the external side, the funding from Qatar, assuming it materializes fully and in a timely fashion, appears small relative to Turkey’s gross external funding needs. It also doesn’t come with the IMF imprimatur that reassures many investors. And it is far from clear how this money will make its way into the economy to maximize the potential for currency stabilization.

And then there is the trade skirmish with the US.

Like other countries, it is only a matter of time until Turkey comes to the same realization as others about confronting the more protectionist stance adopted by the US. Because of its size and systemic influence, and assuming it remains willing to incur the risk of suffering some damage in the process, the US is destined to win a tit-for-tat tariff escalation. As such, the best approach is what the European Union decided to do last month: seek a way to pause the skirmish while working on the longer-term underlying issues.

Rather than rewriting the game plan for crisis management in emerging markets, Turkey may well end up confirming it. One hopes this will lead to the restoration of financial stability and growth as the government looks to reverse its stance on central-bank independence, interest-rate policy, and perhaps even the IMF. The alternative – persisting with the current approach and, in the process, running the risk of turning technical dislocations into much more damaging longer-term economic and financial disruptions – would also prove problematic for other emerging economies.

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We’re almost there: in just 4 trading days, the S&P 500 “bull market” which has purchased by central banks with trillions in liquidity and by companies with even more trillions in buybacks, will become longest of all-time.

And yet away from the S&P, BofA’s Michael Hartnett notes that “there have been so many grizzly bond, commodity & equity market returns this year”: for example, global bonds are annualizing their worst price return (-3.5% local currency) since 1999; 11 of 21 commodity markets have experienced “bear” markets; 1254 ACWI constituents out of a universe of 2273 are in bear markets (i.e. down >20%).

Just as ironically, less than a month after the record bull run anniversary comes September 15th, which marks the 10-year anniversary of Lehman bankruptcy & Global Financial Crisis; what happened next is precisely why the bull market is about to be longest in history:

central banks immediately adopted extreme & unprecedented monetary policies (705 rate cuts, $12.4tn QE, lowest global rates in 5000 years) successfully preventing debt default & deflation, reflating Wall St…catalyzing one of the greatest credit & equity bull markets in history.

Meanwhile, just as fascinating are all the assets that 10 years later actually remain below their Sept 14th 2008 levels…oil, industrial metals, equity markets in Italy, Spain, Russia, Brazil, Turkey, global equity sectors such as energy & utilities, and most glaring of all, the European & the Japanese banks; the central banks prevented debt deflation, but they did not inflate indebted assets.

And while the S&P has so far been spared, “the end of the excess liquidity regime in 2018 has been the main factor behind the grizzly bond, commodity & equity market returns this year” (with the very conspicuous exception of the US dollar, the NASDAQ & the S&P500):

• YTD global returns of US dollar 5%, commodities 2%, stocks 1%, cash 1%, high yield -1%, government bonds -2%, investment grade -3%…truly disappointing given global synchronized recovery, multi-decade unemployment lows in US, UK, Japan, Germany, 4% US GDP growth, record global EPS, $1tn US stock buybacks, $1.5tn US tax cuts
• Global bonds (as measured by the $51tn ICE BofAML global fixed income index) are annualizing their worst price return (-3.5% local currency) since 1999
• 11 of 21 commodity markets have experienced “bear” markets (i.e. >20% peak-to-trough decline) and a further 9 “corrections” (i.e. >10% peak-to-trough declines)
• 12 of 45 MSCI country indices are in “bear” markets and a further 17 equity indices have experienced “corrections”
• The MSCI World Index (equal-weighted) is down 14% since its Jan highs (Chart 3); 1254 ACWI constituents out of a universe of 2273 are in bear markets (i.e. down >20%)
• And the S&P500 summer surge had been unambiguously led by defensives (top 5 performing US sectors past 3 months = staples, utilities, REITs, health care, telecoms, in that order)

Yet even as the S&P has managed to decouple from the rest of the world, the clouds are gathering as the stealth bear market of 2018 threatens to spillover into the US.

Here Bank of America once again resorts to the 3P – Positioning, Profits, Policy – that dictate tactical and cyclical shifts in credit & equity markets.

Of the three, Positioning is the #1 positive for risk assets according to Hartnett. In January, BofA’s Bull & Bear Indicator hit 8.6 indicating a “euphoric” market; in contrast by June the same indicator was signaling very-close-to-but-not-quite-Despair, having dropped to 2.3.

Currently we are only marginally above (3.0) the “extreme bear” levels, hence our view that summer “pain trade” was up. Sadly contrarian upside has been limited to the market with the buybacks: the US.

At the same time, thanks to Trump tax reform, corporate profits have surged in 2018: 23% in the US, 10% in the rest of the world. However, corporate bonds & equities have played “buy-the-rumor, sell-the-fact” with EPS in 2018 and in recent months lead indicators of global profits, such as Korean exports (note Japanese export growth negative in July in the chart below)…

… European & Chinese PMIs, and global trade volumes…

… confirm that global economic momentum & profit growth peaked in March.

Meanwhile, the US yield curve is now <25bps from inversion (has signaled 7 out of past 7 recessions). We suspect the weak US housing market portends a shift in the US macro narrative to peak US GDP, yields & US dollar in the next 3-6 months.

At the same time, there is a growing need political and social need to transition from QE to PE (“Populist Easing” via Keynesianism, Redistribution, and Protectionism) which is already proving less asset-price friendly. This trend is likely to worsen as politicians voice support for central bank subservience, Occupy Silicon Valley policies, and regulation/taxation of stock buybacks in the name of wealth inequality.

And of course monetary policy stimulus has also peaked: Central bank asset purchases were $1.60tn in 2016, $2.30tn in 2017, but are just $0.16tn thus far in 2018, and by year-end global liquidity will be contracting.

The imminent contraction of global liquidity has already been sniffed out by the “canary-in-the-coalmine” asset class of Emerging Markets. Picking up on what SocGen noted three weeks ago, when it highlighted a “near unprecedented” divergence in the FX market between EMs and Developed Markets, BofA shows that EM volatility relative to G7 FX vol is now at a 10 year high.

What happens when EMs finally crack, with or without the developed markets: according to BofA, “ultimately, the Fed will work out that a levered financial market and economy can’t cope with higher rates and they will stop“:

Share buybacks with borrowed money is leverage, private equity are leveraged equity portfolios, tax cuts financed with Treasuries is leverage, pension fund liabilities in excess of assets is leverage

Ultimately, a cynical if accurate argument for financial assets is simply that “US policy makers cannot take the risk of letting asset prices cause a recession”: US financial asset prices as a share of US GDP are now at a record high.

And since Wall St deflation, rather than Main St inflation, is the quickest route to recession, the Fed will have no choice but to prop up markets once more.

The question is when… here is BofA’s forecast:

Until the Fed blinks (likely December at the earliest) and until KOSPI & copper indicate that Chinese policy makers have eased big to stimulate Asian growth, we believe the double-whammy of Peak Profits & Peak Policy stimulus will overwhelm Bearish Positioning; we retain defensive, bearish recommendations.

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To contain the historic plunge of its currency, this week Turkey unleashed an unprecedented barrage of interventions in its market, if not the economy, mostly focusing on crushing short sellers and making shorting the Lira by speculators prohibitively expensive.  In fact just moments ago, the Turkish banking regulator launched yet another intervention:

• *TURKEY EXPANDS LIMITS ON FX SWAPS TO SOME LIRA FORWARDS

The one thing Turkey did not do, is despite vague promises of fiscal reform and monetary stabilization, it continues to refuse to do the one thing investors across the globe demand: raise rates and tighten financial conditions.

Confirming that this is the missing link, in a report this morning, Fitch said that Turkey’s incomplete policy response to the lira’s depreciation “is unlikely on its own to sustainably stabilize the currency and the economy.”

The rating agency, which one month ago downgraded Turkey to BB outlook “negative’ with more downgrades set to come, said that it believes “this would require an increase in the policy credibility and independence of the central bank, tolerance of weaker growth by policymakers, and a reduction in macroeconomic and financial imbalances.”

None of those are forthcoming as a result of Erdogan’s stongman tactics.

Meanwhile, in further pain for the Turkish economy, today the lira resumed its slide after a Turkish court rejected an American pastor’s appeal for release, drawing a stiff rebuke from President Donald Trump who said the United States would not take the detention “sitting down”.

“They should have given him back a long time ago, and Turkey has in my opinion acted very, very badly,” Trump told reporters at the White House, referring to Brunson. “So, we haven’t seen the last of that. We are not going to take it sitting down. They can’t take our people.”

It was not immediately clear what additional measures, if any, Trump could be considering. U.S. Treasury Secretary Steven Mnuchin told Trump at a cabinet meeting on Thursday that more sanctions were ready to be put in place if Brunson were not freed.

And as traders once again sold off the Lira, they pushed the return on the Turkish currency down to 37%, making it tied with the Argentine Peso for worst performing currency of 2018.

What happens next? Well, as Fitch explained in its detailed note, absent Erdogan folding and conceding his “new economics” have been wrong, the Lira will continue to suffer until eventually Fitch – as well as S&P and Moody’s – all downgrade Turkey to junk and below as its economic unraveling becomes unfixable.

Below is the full Fitch text (link):

Turkey Moves Insufficient to Restore Policy Credibility

The Turkish lira recovered somewhat this week after falling below TRY7 to the dollar, but is still down around 35% against the dollar in the year to date. Foreign exchange reserves (including gold) dropped to USD96.8 billion at end-June from USD110.4 billion at end-April.

The Central Bank of the Republic of Turkey raised the effective interest rate by 150bp through providing liquidity at the overnight interest rate of 19.25% rather than the main one-week repo rate of 17.75% and reduced reserve requirements to provide an additional USD10.7 billion of liquidity for domestic banks. The banking regulator has also restricted lira short-selling. On Thursday, Treasury and Finance Minister Berat Albayrak reiterated the goals of reducing inflation and the current account deficit, maintaining fiscal discipline and structural economic reform.

Efforts to fill the initial policy vacuum have helped stabilise the lira, as has a pledge from Qatar to invest USD15 billion in Turkey, although details and timing of the investment have not been disclosed. Albayrak ruled out capital controls on Thursday, and we do not believe these are likely as Turkey needs to attract large capital inflows. Nor do we believe Turkey will seek an IMF programme, unless the situation worsens materially, as this would be politically unpalatable.

However, an ad hoc and incomplete policy response cannot fully address the underlying causes of the lira’s fall, namely the large current account deficit and external financing requirements, the jump in inflation (to 15.9% in July), the build-up in foreign currency debt, and deterioration in economic policymaking credibility. These expose Turkey to a more challenging global financing environment, including a stronger US dollar, rising US interest rates and trade tensions, and a deteriorating political relationship with the US. Heightened risks to macroeconomic stability and the challenges of engineering an economic soft landing were key reasons why Fitch downgraded Turkey’s sovereign rating to ‘BB’ from ‘BB+’ and assigned a Negative Outlook on 13 July.

Bilateral support such as that pledged by Qatar is unlikely to meet Turkey’s external financing requirements without a sustainable policy adjustment. We estimate Turkey’s gross external financing requirement at USD229 billion in 2018 (including short-term debt), well in excess of official foreign exchange reserves.

In Fitch’s view, evidence of an appreciation of and genuine commitment to orthodox monetary policy from the top of the Turkish administration, and greater detail on policy measures in the new administration’s economic agenda, plus a track record of implementation, are likely to be required to restore lasting market confidence. Markets appear to believe that only a further increase in the main policy interest rate (which has already been raised by 500bp since April) would establish a sufficient real rate reflective of the risk premium, demonstrate policy credibility, support disinflation, re-establish a nominal anchor and attract capital inflows.

The abrupt tightening in financial conditions will sharpen the slowdown in GDP growth already under way. A slowdown from 2017’s unsustainable 7.4% growth and some depreciation of the real exchange rate were inevitable to reduce imbalances. Turkey’s vibrant economy and favourable medium-term growth potential support sovereign creditworthiness, as does low government debt (28% of GDP at end-2017, of which foreign-currency debt was only 11% of GDP). But the absence of an orthodox monetary policy response to the lira’s fall, and the rhetoric of the Turkish authorities have increased the difficulty of restoring economic stability and sustainability.

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