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Heading into today’s much anticipated speech by Turkey’s president Erdogan, market expectations were high for at least a trace of conciliation; some analysts even expressed hopes that the central bank, i.e. Erdogan, would greenlight a rate hike as follows:

• Fidelity: 1000bps would be a “good start”
• SocGen: 600bps
• ADM’s Ostwald: 500bps + IMF’s bailout
• UBS: 350-400bps

However, it was not meant to be, and it will probably not comes as a great surprise that the recently crowned “executive president” took the populist route and again urged Turks to “reach for the FX savings under their mattresses and sell them for liras” which he said is going to be the most effective response to the West… although probably not, because as Bloomberg points out, according to the the latest data Turkish residents held $158.6 billion dollars of FX deposits as of Aug. 3, and the number has surely risen in the past week.

Here is the punchline from his speech:

“We’re going to continue to respond in kind to hands extended in friendship. Still, we have plans against all possibilities. I’m calling on interest rates lobbies: don’t get high on your ambitions. You won’t be able make money on the back of this nation. You won’t be able to make this nation kneel.”

Some more highlights from Erdogan’s defiant speech:

• Turkey won’t give in to economic hitmen
• “It’s a national, local struggle. It’s going to be my nation’s response to those waging an economic war against us”
• The “interest rate lobby” won’t be able to bring Turkey down
• Sees “no issues in Turkey macroeconomic data, banking system.”
• Turkey’s facing a wave of artificial financial instability
• Turkey’s prepared for all possible negative developments
• Turkey’s facing a wave of “artificial financial instability”
• Turkey’s made headway in “alternatives” from China and Russia to Iran

As Bloomberg points out, the reference to China, Russia and Iran “will set off alarm bells in Washington.”

Turkey has plans to buy S-400 surface-to-air missiles from Russia, which NATO says are not inter-operable with NATO forces. Turkey was the first country Putin visited after his March 18 re-election. Cooperation between Russia and Turkey — on nuclear power, energy pipelines, arms and tourism — is at record levels.

The rest of the speech was more of the same, which the market quickly interpreted as Erdogan’s defiance and unwillingness to change course, and as a result the Lira collapse has resumed…

… Turkish yields have resumed their surge to all time highs…

… and the TUR ETF is plunging.

Meanwhile fears of Turkish contagion have sent European banks tumbling to the lowest level since July 23.

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Authored by Nick Cunningham via Oilprice.com,

Canadian oil producers are once again suffering from a steep discount for their oil, causing the largest spread between Canadian oil and WTI in years.

Western Canada Select (WCS) recently fell below $40 per barrel, dropping to as low as $38 per barrel on Tuesday. That put it roughly $31 per barrel below WTI, the largest discountsince 2013.

The sharp decline in WCS prices is a reflection of a shortage of pipeline capacity. Much of the talk about pipeline bottlenecks these days focuses on the Permian basin, and the unfolding slowdown in shale drilling, which could curtail U.S. oil production growth. But Canada’s oil industry was contending with an inability to build new pipeline infrastructure long before Texas shale drillers.

However, the problem has grown more acute over the last 12 months. Even as pipeline takeaway capacity hasn’t budged, Canadian oil production continues to rise. Output could jump by around 230,000 barrels per day (bpd) in 2018, followed by another 265,000-bpd increase in 2019, according to the International Energy Agency.

(Click to enlarge)

As more supply comes online, the pipelines are filling up, and there is little relief in sight. Until Enbridge’s Line 3 replacement is completed – targeted for late 2019 – midstream capacity won’t expand. Enbridge recently received a crucial permit from the state of Minnesota, through which the pipeline will traverse, even though state regulators questioned the need for the pipeline. Environmental groups and Native American tribes affected by the pipeline have vowed to mount a resistance to the replacement and construction of the Line 3, echoing the protests of the Dakota Access Pipeline from two years ago.

“They’re bringing highly toxic, highly poisonous tar sands oil directly through major watersheds and the last standing reserve of wild rice that the Ojibwe have to harvest,” Bill Paulson, a member of the Ojibwe tribe, told CNN last month. “Our culture is the wild rice and gathering and being out in the woods. If there’s a threat to that, then there’s a direct threat to the people.”

It is unclear how this will play out, but the opposition could delay the project beyond the expected start date. That means that the discount for WCS will stick around.

And because there is little, if any, empty space on Alberta’s pipelines, not only will the WCS discount linger, but the benchmark could suffer from higher volatility.

“The Western Canadian oil patch is operating on the edge of available takeaway capacity, which makes discounts especially sensitive to shifts in supply (e.g. Syncrude ramping up from its outage), demand (e.g. higher-than-anticipated Midwest refinery maintenance) or marginal transport capacity (e.g. rail capacity spread too thin),” Rory Johnston, a commodity economist at Scotiabank, told Oilprice.com.

In theory, Alberta could build more refining capacity to process Canadian oil rather than scrambling to find pipeline space or selling at a steep discount, but refineries are expensive, and they would not resolve the problem of takeaway capacity.

“The majority of hydrocarbons produced in Western Canada need to be exported–building additional refineries domestically to get around crude oil pipeline bottlenecks would simply shift it to a product pipeline capacity challenge,” Johnston said. “One way or another, those barrels still need to get to end consumers–either by pipeline, rail, barge, or truck.”

Shipping oil by rail to the U.S. Gulf Coast can cost as much as $20 per barrel or more, according to Scotiabank, double the rate for shipping by pipeline. But with the WCS discount as large as it is, the economics could still work out. However, rail companies have been hesitant to invest in new rail capacity for shipping oil, especially if the business opportunity of doing so only lasts for another two or three years. Still, crude-by-rail shipments have climbed significantly this year, hitting a record high 198,788 barrels per day in May, the latest month for which data is available. However, even if rail economics look attractive, the lack of sufficient capacity means that rail won’t be able to entirely bridge the gap.

With midstream capacity stubbornly stuck without a near-term solution, the Canadian government has moved to essentially nationalize the Trans Mountain Expansion project, buying it from Kinder Morgan after the U.S.-based company moved to scrap the expansion plans.

But on that front as well, Ottawa continues to receive bad news, following its desperate bid to take over the project. The Canadian Press reported on August 7 that expanding the project will cost $1.9 billion more than previously thought, and will take a year longer than expected, putting the start date off until late 2021.

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As diplomatic tensions again escalate between the US and Russia following the announcement of new sanctions against Moscow earlier this week by the Trump administration, Russia’s prime minister Dmitry Medvedev warned the United States on Friday that Russia would regard any U.S. move to curb the activities of its banks as a declaration of economic war which it would retaliate against.

Medvedev said Moscow would take economic, political or other retaliatory measures against the United States if Washington targeted Russian banks.

“If they introduce something like a ban on banking operations or the use of any currency, we will treat it as a declaration of economic war. And we’ll have to respond to it accordingly – economically, politically, or in any other way, if required,” Medvedev said during a trip to the Kamchatka region.

“Our American friends should make no mistake about it,” he cautioned.

Medvedev also noted that Russia has a long history of surviving economic restrictions and never caved in to the pressure in the past. “Our country had been living under constant pressure through sanctions for the last hundred years,” Medvedev said, accusing the US and its allies of employing sanctions to undercut global competition. “Nothing has changed.”

The Russian PM said that by targeting Russia’s gas exports to Europe, Washington wants to push its own LNG shipments to the continent. “It’s an absolutely nonmarket anti-competition measure aimed at strangling our capabilities.” Medvedev also pointed out that the US is simultaneously imposing tariffs on China. “The Chinese, obviously, don’t like it. No one does. And our goal is to resist all these measures.”

According to Reuters, Medvedev’s statement reflects Russia’s fears over the impact of new restrictions on its economy and assets, including the rouble which tumbled 6% of its value this week on sanctions jitters. With economists expecting the economy to grow by 1.8% this year, some fear that if new sanctions proposed by Congress and the State Department are implemented in full, growth would be almost cut to zero.

On Wednesday, the State Department announced a new round of sanctions targeting Russian exports of dual-purpose electronics and other national security-controlled equipment, which will come into effect on August 22, and which pushed the Russian currency to two-year lows and sparked a wider sell-off over fears Russia was locked in a spiral of never-ending sanctions.

Separate legislation introduced last week in draft form by Republican and Democratic senators, dubbed “the sanctions bill from hell” by one of its backers, proposes curbs on the operations of several state-owned Russian banks in the United States and restrictions on their use of the dollar.

Moscow’s strategy of trying to improve battered U.S.-Russia ties by attempting to build bridges with President Trump backfired after U.S. lawmakers launched a new sanctions drive last week because they fear Trump is too soft on Russia. That in turn piled pressure on Trump to show he is tough on Russia ahead of mid-term elections and the possible release of Mueller’s report on Russian collusion.

The problem for Russia is that there is little it could do to hit back at the United States without damaging its own economy or depriving its consumers of sought after goods as the sanctions episode of 2014 showed, and officials in Moscow have made clear they do not want to get drawn into what they describe as a mutually-damaging tit-for-tat sanctions war, similar to the one the US is waging with China.

The threat of more U.S. sanctions kept the rouble under pressure on Friday, sending it crashing past two-year lows at one point before it recouped some of its losses.

Commenting on the currency slide, the Russian central bank said the rouble’s fall to multi-month lows on news of new U.S. sanctions was a “natural reaction” and that it had the necessary tools to prevent any threat to financial stability. One tool it said it might use was limiting market volatility by adjusting how much foreign currency it buys. Central bank data showed on Friday it had started buying less foreign currency on Wednesday, the first day of the rouble’s slide. As a reminder, Russia recently liquidated the bulk of its US Treasurys holdings over the past two months as it sought to diversify away from the dollar.

For now, the fate of the U.S. bill Medvedev was referring to is not certain. Congress will not be back in Washington until September, and even then, congressional aides said they did not expect the measure would pass in its entirety.

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Assume for a second that there were no pending questions facing the Elon Musk proposed MBO of Tesla: that the funding was indeed secured, that the Board has signed off on the deal, that the requisite number of shareholders had agreed to roll their equity into the new structure and so on.

What would such a deal look like?

First, the baseline parameters as defined by Musk: At $420 per share, and using an estimated 186.5MM diluted shares outstanding (including exercisable options, and convertible debt that would theoretically be in-the-money), the implied equity value is approximately $78BN. When combined with an adjusted net-debt of approx. $6BN, this implies an  Enterprise Value of $84BN —which indicatively is 23.5x Goldman’s 2020E EBITDA estimate and 17.5x consensus EBITDA.

The next logical question is what could potential financing and interest expense look like post an MBO, in other words, what does the math of the proposed deal look like? It is here that things quickly turn ugly as an analysis by Goldman’s David Tamberino finds.

According to the Goldman analyst, with $9bn in net-debt, Tesla is currently levered his 2.6x our 2020E EBITDA (and 1.8x on consensus), and the current annual interest expense is tracking toward $650MM — driving an implied average interest rate of approx. 6% (of course a full-blown MBO largely funded by junk debt would have a far higher interest expense). If adjusted for in-the-money convertible notes, leverage would drop to 1.7x GSe 2020 (and 1.2x consensus) —with an implied interest rate of 7.3%.

Assuming the company could fund debt at a similar rate, no other shareholders converted to the private structure, and outside equity capital was not lined up — this would imply debt of $68.5bn with interest expense of approx. $5bn. Not only would that lever the company up to 14x Consensus EBITDA, but the interest expense alone would be higher than forecast EBITDA generation, in other words assuming no capex, the company would be cash flow negative, hardly what any LBO investor wants to hear.

For the pro forma analysis, we take a traditional LBO approach of 6.0x leverage – in-line with historical LBOs – to get $21BN of debt financing on Goldman’s conservative 2020E EBITDA, or $29BN consensus — leaving a need for incremental equity financing in the amounts of $40 to $47bn depending on whether one uses the consensus or Goldman EBITDA. While this would lead to lower interest expense, it would not result in positive cash flow generation when consensus capex of $3.6BN is considered.

To allow for the range of outcomes outside of these two structures, Goldman has created the following sensitivity analysis showing potential interest expense at various funding structures.

With that hypothetical analysis in mind, the next and key question is does $420/share represent fair value?

The answer is: it depend on your views of the company’s growth.

For this analysis we revert to Goldman’s operating assumptions, and specifically the bank’s “potential upside” scenarios, in which – even when faced with growing competition from OEMs – the company achieves mass market volumes in the 2 to 3 million vehicle range in 2025; for context, Goldman’s base case assumes only ~800k in 2025.

In those upside scenarios, Goldman ascribes valuations (discounted back to early 2019) for the overall company that average to approx. $414 per share. Naturally, Goldman is quick to point out that its base case valuation implies a much lower potential value per share for Tesla – roughly $116 or nearly a quarter of Musk’s proposed take out value – given the slower growth rate and forecasted lower margin profile.

Finally, some have wondered whether the Dell MBO is an applicable comparable case study? The answer, according to Goldman, is maybe, but the underlying EBITDA/FCF characteristics were far more favorable.

A quick flashback of what that deal looked like: In 2013, Dell management led a buyout of the company for $25bn — financed through management’s ownership stake (16%, valued at over $3bn), $750mn in cash on the balance sheet, some incremental equity holders, and debt of approx. $19.4bn (debt-to-equity ratio of 3.5x). While the transaction was somewhat similar in nature to what is being proposed at TSLA, the EBITDA generation and cash flow characteristics of the business were very different given a more mature product and growth profile: Dell’s reported 2013 adjusted EBITDA was $5.1bn (implying 3.4x leverage at-close) and FCF generation was approx. $3BN.

By Comparison, excluding working capital gimmicks, Tesla is run rating around $1 billion in cash flow burn per quarter.

In other words, even if one assumes that all the MBO preconditions are in place, and Musk does indeed have the financing locked up, the far bigger question is just who would have agreed to lock themselves up to a capital structure that is more suitable for a mature, cash flow generating business, whereas Tesla still remains largely in the realm of pure equity – after all just the interest expense alone would leave zero residual cash for equity investors.

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For once it’s not about trade wars… but the alternative is hardly better.

European stocks tumbled most in a month, following Asian shares lower following contagion fears that Turkey’s economic problems will spill over into the euro zone and beyond. The Euro sank, while the safe haven dollar advanced alongside Treasuries, with the 10Y back under 2.90%. The Turkish Lira initially plunged and fell 45 big figures, with the USDTRY hitting a record high of 6.3005, or up more than 11%, before holding below 6.0 for the bulk of the session.

As described earlier the collapse started around midnight EDT when the FT reported that the ECB Single Supervisory Mechanism warned that BBVA, UniCredit and BNP Paribas are particularly exposed to a TRY selloff, and even though it “does not see situation as critical yet”, it warned that the risk is that Turkish borrowers may not be hedged against TRY weakness and begin to default on foreign- currency loans.

There is some hope that Turkish President Erdogan’s speech at 12 p.m. London time will calm matters but his earlier ad hoc comments did not give much room for optimism. Speaking outside a mosque earlier today, Erdogan told followers “Don’t forget this: if they have got dollars, we have got our people, our right, our Allah.”

Commenting on the statement, Bloomberg macro analyst Stephen Kirkland said that it signals he’s sticking to a nationalist message and is uninclined to deliver the hard measures Turkish assets need, which according to some analysts such as ADM’s Marc Ostwald include a 500 bps rate hike and an IMF bailout. As a result, option markets are now pricing in a one-in-five chance of USD/TRY reaching 7 per dollar in a month, from about 1% probability yesterday.

For the Turkey watchers, here is today’s key sequence of events, all times London:

• 12.00BST: President Erdogan to speak
• 12.30BST: Finance Minister Albayrak announces new economic model
• 14.30BST: President Erdogan to speak again

And as fears of contagion mounted, the EURUSD tumbled to the lowest level in a year, running stops as it broke below the barrier level of 1.15…

… as the DXY spiked to YTD highs amid a broad flight to safety with the USD bid seen across all pairs. The scramble for safety meant that both USTs and bunds rallied however in a more contained manner and the 10Y bund yields were lower by ~3.5bps.

In equities, Europe’s Stoxx Europe 600 Index dropped with European equity markets selling off steadily as banks underperformed with BBVA, UniCredit and BNP Paribas – the three banks named by the ECB – in focus as all three fall 3.5-4.0%. Mining stocks also weaker as Russia considers a new mining tax of $7.5b, which also weighed on metals across the board.

U.S. equity futures declined alongside shares from Asia to Europe. Asian equity markets were also mostly negative with sentiment subdued. The ASX 200 (-0.1%) and Nikkei 225 (-0.7%) were lower with Australia weighed by weakness in energy stocks, while Tokyo trade failed to benefit from stronger than expected GDP amid a firmer currency. Elsewhere, Shanghai Comp. (-0.1%) and Hang Seng (-0.4%) traded choppy amid a lack of fresh drivers and after the PBoC refrained from operations again for a neutral position for the week.

“We’re going to have the uncertainty about Erdogan and him speaking later today that I think is going to keep the market volatile,” said Peter Chatwell, head of European rates strategy at Mizuho International, in a Bloomberg Television interview. “But probably some of the market reaction we had first thing this morning could start to retrace a bit.”

As has been the case for much of 2018, geopolitical tensions between the U.S. and other countries had set the tone for markets this week, with the latest leg of the lira’s downward spiral triggered by a diplomatic row with America. Earlier in the week, China responded to the Trump administration’s latest trade war volley with additional tariffs of its own.

Elsewhere in FX, via BBG:

• The pound sank to the lowest since June 2017 against the dollar, and held the losses even after data showed the U.K. economy expanded 0.4% between April and June, in line with the median forecast in a Bloomberg survey
• Norway’s krone enjoyed support from a better-than-forecast inflation report while Sweden’s krona weakened after price data matched estimates
• China’s yuan extended its drop, heading for the biggest fall in three weeks
• The ruble hit a two-year low after the U.S. announced new sanctions on Russia over the March 4 nerve-agent attack on a former double agent in the U.K.

Oil is still set for its 6th weekly loss as the crude complex is being hit by a rising USD, and risk aversion with both WTI and Brent down ~0.8% on the day, and Brent set for a near 2% and WTI looking at a near 3% fall for the week. In the metals complex, gold is down and straddling the USD 1210/oz level, as the rising dollar is hitting the gold market, which is looking at its 5th consecutive weekly fall. Copper has given up gains seen in early trade and is currently down 1.1% as an 11.3% fall in copper inventories seen by ShFE over the past week has not counteracted the USD hitting 13 month highs

Today’s economic data include CPI and the monthly budget statement

Market Snapshot

• S&P 500 futures down 0.4% to 2,842.25
• STOXX Europe 600 down 0.7% to 387.50
• German 10Y yield fell 3.7 bps to 0.338%
• Euro down 0.6% to $1.1453
• Brent Futures down 0.2% to $71.95/bbl
• Italian 10Y yield fell 1.6 bps to 2.628%
• Spanish 10Y yield fell 1.2 bps to 1.382%
• MXAP down 1% to 165.29
• MXAPJ down 1% to 536.41
• Nikkei down 1.3% to 22,298.08
• Topix down 1.2% to 1,720.16
• Hang Seng Index down 0.8% to 28,366.62
• Shanghai Composite up 0.03% to 2,795.31
• Sensex down 0.3% to 37,921.73
• Australia S&P/ASX 200 down 0.3% to 6,278.39
• Kospi down 0.9% to 2,282.79
• Brent Futures down 0.1% to $71.98/bbl
• Gold spot down 0.4% to $1,207.93
• U.S. Dollar Index up 0.6% to 96.09

Top Overnight News

• European Central Bank’s Single Supervisory Mechanism sees BBVA, UniCredit and BNP Paribas as particularly exposed to the Turkish lira’s plunge, Financial Times reported, citing two people familiar with the matter who it didn’t identify
• The Teachers Insurance & Annuity Association of America is among a number of pension and investment funds that hold hard-currency debt issued by Turkish banks, according to Bloomberg data. The lira’s 2018 loss exceeded 30 percent this week as investor confidence in the nation’s economic policies waned
• The U.K. economy bounced back from its turgid start to the year in the second quarter but the dominant services sector lost momentum toward the end of the period. Gross domestic product increased 0.4 percent between April and June, in line with the median forecast in a Bloomberg survey
• Fears about global oil supplies have receded after producers pumped more, according to the International Energy Agency, which a month ago warned of a potential shortage
• Iran is slashing the relative cost of its exports versus OPEC’s No. 1 producer Saudi Arabia at a time when buyers in Asia — the world’s biggest oil consuming region — face mounting pressure from the U.S. to halt purchases from the Islamic Republic

Asian equity markets were mostly negative with sentiment subdued after a lacklustre lead from Wall St. where weakness in energy and financials dragged the DJIA and S&P 500, while the Nasdaq just about remained afloat to notch its 8th consecutive gain. ASX 200 (-0.3%) and Nikkei 225 (-1.3%) were lower with Australia weighed by weakness in energy stocks, while Tokyo trade failed to benefit from stronger than expected GDP amid a firmer currency. Elsewhere, Shanghai Comp. (flat) and Hang Seng (-0.8%) traded choppy amid a lack of fresh drivers and after the PBoC refrained from operations again for a neutral position for the week. Finally, 10yr JGBs were higher with demand spurred by losses in riskier assets and with the BoJ also present in the market for nearly JPY 800bln in JGBs. PBoC skipped open market operations and were net neutral for the week vs. last week’s CNY 210bln net drain.

Top Asian News

• Asia’s $184 Billion Debt Wall to Spark Buybacks, Bond Swaps
• Hong Kong 2Q GDP Drops 0.2% Q/Q; Est. 0.2% Rise
• HNA Gives Up Bid to Build a Hotel Empire With Radisson Sale
• Qatar Set to Be Outstripped as World’s Richest Place by Macau

European equities have started the day negative (Euro Stoxx 50 -1.4%) as amid reports the ECB is expressing concerns of a weak TRY on European banks. This is pressuring European banks as a whole (STOXX® Europe 600 Banks (SX7P) -1.7%) as investors are repositioning into safe-haven assets and away from the financial sector, which is the current sector underperformer. BNP Paribas (-3.7%), BBVA (-3.3%) and UniCredit (-3.1%) are bringing up the rear of the Stoxx 600 on the back of high exposure to Turkish assets.

Top European News

• ECB Concerned About European Banks’ Turkey Exposure, FT Reports
• Core Inflation Shortfall Fuels Doubt on Riksbank Tightening Plan
• Lira Plunge Boosts Odds of Turkey Credit Downgrade
• European Banks Decline as Shares of Turkey-Exposed Lenders Slump

In FX, the highlight was the TRY with almost relentless selling early Friday, to the point of a full-on capital flight at one stage, saw the Lira collapse to new all time lows vs the Usd with vendors and price feeds quoting levels for the pair anywhere between 6.0000-50 in fast, if not frantic market conditions. However, some respite for the Try ahead of and after Turkish current account data that was slightly better than forecast in the event, but the focus now very much on speeches from President Erdogan (midday and 14.30BST), and more importantly the Finance Minister’s new economic model (12.30BST). Usd/Try back under 6.0000, but only just. DXY – The index is just off best levels, but riding high near fresh 2018 peaks around 96.182 and still over the big figure amidst widespread Dollar gains, bar vs the safest of safe-haven currencies, Jpy as the aforementioned Lira and EM meltdown spills over to majors. Technically, 96.512 is next on the radar, assuming no intervention to stop the rout and/or a major upset for the Greenback independently (weak CPI data?). JPY – As noted, the exception to the rule, as Usd/Jpy trades mostly below 111.00 on risk-off positioning and the Jpy is also boosted by stronger than forecast Japanese GDP data overnight. Chart-wise, 110.53 represents nearest support and bids/stops are likely situated around 110.50.

In commodities, oil is set for its 6th weekly loss as the crude complex is being hit by a rising USD, and risk aversion with both WTI and Brent down ~0.8% on the day, and Brent set for a near 2% and WTI looking at a near 3% fall for the week. In the metals complex, gold is down and straddling the USD 1210/oz level, as the rising dollar is hitting the gold market, which is looking at its 5th consecutive weekly fall. Copper has given up gains seen in early trade and is currently down 1.1% as an 11.3% fall in copper inventories seen by ShFE over the past week has not counteracted the USD hitting 13 month highs. Aluminium is also down 0.5% on the day. IEA raise their 2018 oil demand growth forecast by 110k BPD to 1.49mln BPD, and see risks to 2019 oil demand growth from trade disputes and rising prices if supply is constrained.

Looking at the day ahead, the highlight is likely to be the July CPI report in the US. Prior to that we get the preliminary Q2 GDP reports in the UK. June industrial production data is also due out in France and the UK as well as June trade data in the latter. In the evening we’ll also get the July monthly budget statement in the US. Gazprom will report earnings.

US Event Calendar

• 8:30am: US CPI MoM, est. 0.2%, prior 0.1%; CPI Ex Food and Energy MoM, est. 0.2%, prior 0.2%
• 8:30am: US CPI YoY, est. 2.9%, prior 2.9%; CPI Ex Food and Energy YoY, est. 2.3%, prior 2.3%
• 8:30am: Real Avg Weekly Earnings YoY, prior 0.2%; Real Avg Hourly Earning YoY, prior 0.0%
• 2pm: Monthly Budget Statement, est. $76.0b deficit, prior $42.9b deficit

DB’s Jim Reid concludes the overnight wrap

Markets are undoubtedly quiet at the moment but there are some big moves still in Turkey and Russia that are preventing everyone from enjoying the summer. Firstly the S&P 500 closed -0.14% after a dip in the last 15 minutes before the bell but the index again traded in a fairly narrow 0.37% range for the day – the 8th lowest this year. Meanwhile the Turkish Lira dropped -5.15% to a fresh record low (YTD -46.2%) and the 13th worst day since 2000. Ankara’s jailing of the America pastor and the associated diplomatic row continues to hurt the country’s assets. Not even the Turkish Treasury and Finance Minister Berat Albayrak’s office saying that the government would curb sovereign borrowing by reducing the GDP growth target to under 4% from 5.5% had an impact beyond a brief and small intra-daytick up in the Lira. President Erdogan speaks today at 2pm local time so it’ll be interesting to see if anything important comes from that. Meanwhile the Russian Ruble fell -1.72% (YTD -15.7%) to the lowest since April 2016 as the prior night’s US sanctions continued to dampen sentiment. Countries that are in a diplomatic battle with the US at the moment (e.g. China, Turkey and Russia) seems to be suffering in the markets.

The main highlight today is US CPI. DB expects core inflation (0.23% month-over-month) to rebound in July after a few softer monthly prints. According to our team, over the past three months, core CPI has risen at an annualized rate of only 1.74%, well below the year-over-year and 6-month annualized rates which are both near 2.3%. Their forecast is supported by recent firmer readings for alternative inflation gauges and expectations for a rebound in a few categories that have been unusually soft in recent months. A print in line with DB’s forecast would lift the YoY rate for core CPI inflation to 2.32%, which would support the long-standing house call for two more rate hikes this year.

Ahead of this, this morning in Asia, markets are retreating modestly with China’s CSI 300 broadly flat (+0.02%) while the Hang Seng (-0.45%), Nikkei (-0.72%) and Kospi (-0.66%) are all down as we type. Meanwhile futures on the S&P are pointing to a softer start while the Chinese Yuan is resuming its decline (-0.2%). Datawise, the rebound in Japan’s Q2 GDP was stronger than expected at 0.5% qoq (vs. 0.3% expected), leading to an annualised growth of 1.9%. Back to other markets performance from yesterday. In the US, the Nasdaq edged up for the 8th straight day (+0.04%), closing in on matching its prior winning streak of 9 days in late September 17. Meanwhile Tesla fell for the second day (-4.83%) and was down -9.0% from its intraday high a few days back, in part as investors scrutinised the potential to take the company back to private ownership.

Notably, Tesla rose c2% in after hour trading though after CNBC reported that its Board of Directors plans to meet with financial advisers next week to explore taking the company private, although Reuters cited unnamed sources which noted the board has not yet received a detailed financial plan from CEO Musk. So one to watch.

In Europe, the Stoxx 600 reversed earlier losses to close +0.09% as consumers stocks benefited from better than expected results from Adidas (+8.6%) and Cineworld (+10.7%). Across the region, the DAX (+0.34%) and CAC  (+0.01%) nudged higher while the FTSE (-0.45%) gave back some of its gains from the prior day. Over in government bonds, core 10y yields were around 2bp lower (Bunds -2.3bp; Gilts -1.9bp) while treasuries outperformed (-3.4bp), in part following a weaker than expected PPI print (more below). Turning to currencies, the US dollar index firmed 0.43% to a fresh 13 month high while the Euro and Sterling fell -0.71% and -0.45% respectively. In commodities, WTI oil softened further (-0.19%) while precious metals were little changed (Gold -0.12%; Silver +0.11%).

In other news, Business Insider reported that some member states in the EU are ready to allow UK to remain in the single market for goods while opting out of the free movement of people if UK agrees to replicate all environmental, social, and customs rules in addition to those set out in her so-called Chequers proposals. The potential trade-off will apparently be discussed at a special meeting of all 28 leaders in Salzburg next month. It doesn’t seem likely that the EU would be this generous at this stage and after a brief spike GBP largely ignored the story and closed -0.45% and -0.27% lower against the USD and EUR.

Finally turning to the latest central bankers speak. The Fed’s Evans, one of the more dovish Fed members seems to be shifting his tone as he noted that “it would not surprise me…if we make a judgement to move to a somewhat restrictive setting” on rates, which he believes could be roughly 50bp above his 2.75% estimate of neutral rates. Nearer term, he believes “it could be one or two more” rate hikes for the year. Meanwhile he pointed to the economy’s “extremely  strong” performance and he thinks “inflation expectations are going to catch up”. Back in the UK, the outgoing BoE policy maker McCafferty told the Guardian that wage growth might “creep up towards 4 percent-ish” in 2019, in part driven by a labour shortage and he sees “another couple” of rate hikes in the next 18 months to two years.

Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the July core PPI (ex food & energy) was 0.1ppt below expectations, coming in at 0.1% mom and 2.7% yoy. The weakness was in   part due to the decline in wholesale prices for apparel (-4.4% mom) and furnishings (-3.2% mom). Meanwhile, our US economists noted the healthcare component – used as an input in the core PCE deflator, was up just +0.03% in July leaving its annual growth rate steady at 1.7% yoy. Elsewhere the final reading for the June wholesale inventories was revised one-tenth higher to 0.1% mom. The weekly initial jobless (213k vs. 220k expected) and continuing claims (1,755k vs. 1,730k expected) remain near historic low levels and continue to reflect robust labour market conditions. Back in the UK, the June RICS housing survey reported that a net 4% of surveyors had seen house price increases over the past three months – up slightly from the June survey.

Looking at the day ahead, the highlight is likely to be the July CPI report in the US. Prior to that we get the preliminary Q2 GDP reports in the UK. June industrial production data is also due out in France and the UK as well as June trade data in the latter. In the evening we’ll also get the July monthly budget statement in the US. Gazprom will report earnings.

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The Turkish currency crisis is finally here and it is sending shockwaves around the globe.

After weeks of a slow, but controlled collapse, investors finally hit the panic button overnight, when the Turkish lira crashed as much as 11.2% against the dollar as concern over contagion from Europe’s exposure to the Turkish economic devastation overshadowed promises by the Turkish government to bolster the economy.

The Turkish Lira plunged to a record low of 6.3005 per dollar on Friday morning, before rebounding modestly to 5.88, and is now down more than 35% in the year to date.

Friday’s fall has made the Turkish Lira the worst performing emerging market currency in 2018 and as the currency was headed for its worst week since 2001, its YTD collapse has surpassed even the Argentine Peso.

“Seems like a complete crash, so they need to act now,” said a stunned Morten Lund, strategist at Nordea Bank in Copenhagen. “The lira will keep falling if they don’t hike rates today.” Then again with Erdogan’s stated preference that rates never go up, it is quite possible that nothing happens.

The collapse also slammed Turkey’s bond market, sending the yield on 10-year government bonds soaring by 93bps to a new record high of 20.67%.

Friday’s fall came after the Financial Times reported that supervisors at the European Central Bank are concerned about exposure of some of Europe’s biggest lenders to Turkey, including chiefly BBVA, UniCredit and BNP Paribas. The FT reported that along with the currency’s decline, the ECB’s Single Supervisory Mechanism has begun to look more closely at European lenders’ links with Turkey. The moves also came after the US showed no signs of lifting crippling sanctions despite the visit of a Turkish delegation to the US capital.

According to the FT, the ECB is concerned about the risk that Turkish borrowers might not be hedged against the lira’s weakness and begin to default on foreign currency loans, which make up about 40% of the Turkish banking sector’s assets.

And while it does not yet view the situation as critical, it sees Spain’s BBVA, Italy’s UniCredit and France’s BNP Paribas, which all have significant operations in Turkey, as particularly exposed, according to two people familiar with the matter.

The ECB news hit Turkey like a rock: “The key to any hope of Turkish stability is the ability for banks to roll over syndicated loans — so far, that’s been absolutely fine,” said Paul McNamara, a money-manager at GAM UK in London. “I think the FT thing about the ECB being worried about Turkey exposures is a huge new factor.”

Contagion quickly spread as the banks named by the ECB as exposed to Turkey saw their stocks plunge as the shockwave spread around the world: Europe’s banks opened on Friday under pressure. The Euro Stoxx Banks index dropped 0.5% in early trading, with BBVA, UniCredit and BNP Paribas among those drawing most scrutiny. Shares in BBVA, UniCredit and BNP Paribas were all down more than 3% on Friday morning.

“We’re likely to see some weakness across the board,” said Kit Juckes, a macro strategist at Société Générale, noting the weight the issue has already imposed on the euro.

Of course, it will be local bank that go first: as a reminder, earlier this week, Goldman published a research report, according to which a drop in the lira to TL7.1 against the dollar “could largely erode banks’ excess capital”.

Renaissance Capital’s chief EM economist Charles Robertson  said: “The markets have lost confidence in the triumvirate of President Erdogan, his son-in-law as finance minister and the [central bank’s] ability to act as it needs to.”

Jane Foley, head of foreign exchange strategy at Rabobank, added that Erdogan’s “defiant” comments on Thursday night “had reduced the markets’ hope” that the Turkish government is willing to tighten monetary policy or begin economic reform.

Meanwhile, Turkey continues to pretend that all is well, and on Thursday the Turkish finance ministry said that the banking sector was protected by its robust capital structure and balance sheets. “Contrary to the speculative statements being made in the market about our banks and our companies, our regulatory institutions do not see a problem posed by the exchange rate or liquidity risks.”

As the FT adds, according to cross-border banking statistics from the Bank for International Settlements, local lenders, including foreign-owned subsidiaries, have dollar claims worth $148bn, up from $36bn in 2006 and euro claims worth $110bn. Spanish banks are owed $83.3bn by Turkish borrowers, French banks are owed $38.4bn and Italian lenders $17bn in a mix of local and foreign currencies. Banks’ Turkish subsidiaries tend to lend in local currency.

Curiously, ahead of the ECB’s warning, all the named banks with exposure to Turkey were rather sanguine:

Carlos Torres Vila, chief executive of BBVA, which owns just under half of Turkey’s Garanti Bank, said last month that the group was “really very, very well prepared for the situation”. He said the bank had reduced the weight of its foreign currency loan portfolio and increased the weight of inflation-linked instruments.

Separately, earlier this week, analysts asked UniCredit whether it would need to write down its €2.5bn investment in its 40.9 per cent holding in Turkey’s Yapi Kredi, after the lira’s depreciation dragged the stake’s market value down to €1.15bn. UniCredit responded that Yapi Kredi’s underlying performance was good and the foreign exchange impact would be absorbed by its own reserves. But Goldman analysts said this week that they viewed “Yapi Kredi as the weakest positioned of Turkey’s biggest banks” in terms of capitalisation.

BNP Paribas holds 72.5 per cent of retail bank TEB. One person close to the French lender said its exposure to Turkey was “very limited” at close to 2 per cent of overall group commitments.

* * *

The unprecedented turmoil threatens to scare away the foreign capital Turkey depends on to finance its large external deficit, and hampers companies’ ability to repay foreign-currency loans. Not helping, the government cut its 2018 growth target Thursday to less than 4% from 5.5%, a sign that it is willing to accept a more moderate pace of expansion in an effort to rebalance the economy, Bloomberg reported .

There is some hope for damage control: Treasury and Finance Minister Berat Albayrak, the president’s son-in-law, is due to hold a press conference this afternoon, although it is unlikely he will announce what analysts believe are the appropriate measures.

The revisions are unlikely to be enough “to lead to a recovery in markets,” said Erkin Isik, a strategist at Turk Ekonomi Bankasi AS. “If the currency remains at current levels, headline inflation is likely to approach 18 percent year-over-year by September. As a result, current policy rate at 17.75 percent is not tight enough.”

* * *

Today’s meltdown took place ahead of a much-anticipated public address by President Recep Tayyip Erdogan.

Speaking outside a mosque earlier today, Erdogan told followers “Don’t forget this: if they have got dollars, we have got our people, our right, our Allah.”

Commenting on Erdogan’s statement, Bloomberg macro commentator Stephen Kirkland said that it signals he’s sticking to a nationalist message and uninclined to deliver the hard measures Turkish assets need. As a result, option markets are now pricing in a one-in-five chance of USD/TRY reaching 7 per dollar in a month, from about 1% probability yesterday, at which point Turkish excess bank capital is wiped out and the currency crisis becomes a full blown financial panic. Meanwhile, three-month USD/TRY risk reversals have shot up to the highest since 2009 and lira forward points have never been this high in Bloomberg data that goes back to December 1996.

That market capitulation offers Erdogan an element of surprise to turn things around for the lira. Instead, it’s looking increasingly like it may have much further to fall before he takes the necessary action.

As for Turkish Lira longs, Erdogan is rightL: Allah is indeed all that’s left.

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Authored by Duane Norman via Free Market Shooter blog,

German Chancellor Angela Merkel and French President Emmanuel Macron are now faced with their worst public approval ratings, hitting record lows, as conservatism and populism spreads across the European Union.

According to a YouGov poll released last Friday, Macron’s approval rating dropped by five points to 27% against 62% disapproval.

Notably, at this time last year, Macron’s approval rating was at 50%. The sharp drop in support comes after one of Macron’s bodyguards was filmed savagely beating a protester.

Macron’s former bodyguard, Alexandre Benalla, hit and stomped a young man whilst wearing a police visor on May 1st. Benalla, who was not a policeman, had been given permission to “observe police operations” on his day off.

Many accused the incident of being covered up when it was not reported to police and that Benalla’s punishment – two weeks suspension without pay and being transferred to an administrative job – wasn’t enough.

Although the Benalla scandal certainly didn’t help Macron, his low approval numbers come after many conservative victories. In the last year, elections in Hungary, Italy, the Czech Republic, and Austria saw populist movements spring up with citizens voting for strong borders, to protect their heritage, and to reject globalism.

With Macron’s turbulent poll numbers, Germany’s Merkel is also experiencing less-than-stellar performance reviews after public support for her coalition government fell to 29%.

Merkel’s approval rating has fallen since she opened Germany’s borders to more than one million refugees and migrants during the peak of the immigration crisis. Her coalition government’s 29% rating is also the first time in history the alliance has ever dropped below 30%.

As detailed by Breitbart, Merkel barely won a fourth term in September 2017 – with the anti-mass migration Alternative for Germany (AfD) gaining ground.

The AfD also hit a new high of 17% support – and polls even showed that 74% of citizens were unhappy with the current German government.

Across Europe, more and more citizens are waking up to the threat of open borders and illegal immigration. Even if many do hold anti-immigration views or beliefs, they often keep their opinions to themselves after seeing what happens to those who do dare to speak up. However, even if most citizens choose to remain silent in the face of an invading force hellbent on unrooting and transforming their culture, they have made their voices heard through voting.

Populist and conservative movements have sprung up all across Europe, with nationalistic leaders being elected into office in an attempt to curtail and reverse the flow of migrants and refugees into traditional communities – and more movements will certainly keep igniting across the European Union as citizens decide enough is enough and put security and safety ahead of feelings. The citizens across Europe finally standing up must pray, however, that it isn’t too late to put an end to the dire threats infecting their countries.

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“Don’t ask me what you should figure out yourself,” is the blunt message from former fund manager and FX trader Richard Breslow this morning.

“What do you think?” is a question you hear over and over again in the trading world. At least some people are still asking at a period of time when you are more likely to get, “Do you agree with me or not?” Still, the proper answer should be “Why do you want to know?”

Via Bloomberg,

Context is everything. Are you talking about the next five minutes or six months? Is it a theoretical question about what would happen in a perfect scenario, or are you simply asking to be told what to do? What are you planning to do based on the answer? Traders are becoming less clear about what they’re asking for and too often the respondents are forced to wear so many hats that it’s impossible to know how to use their response.

In an increasingly complex environment we are all becoming generalists when it’s arguable that having a specialty is an underappreciated attribute. In the financial realm it’s easy to see how the last 10 years, in so many ways, contributed to this situation. As have structural changes and economic realities in the industry. Not to mention, to use the term kindly, technological advancements. Computers have fooled us into thinking that facts and details are no longer as important.

Correlation matrices are great things to have. They were far more effective for generating alpha when they weren’t the ubiquitous not-to-be-questioned Holy Grail driving the whole shebang. Traders these days struggle mightily whenever an asset goes its own way.

The first reaction is always that it’s out of whack, or a canary in the coal mine. Sometimes things do just change. And boning up on the situation after the fact is always sub-optimal. As is asserting that yes, something may indeed be going on that we were unprepared for, but the base case is this, too, shall pass. You can only use that excuse so many times in letters to your limited partners.

Passive investing is valuable, big and growing. It isn’t going away. And sometimes funds do indeed have positions because they have no choice. Actually scanning the offering circular is worthwhile. But we’ve gone way overboard by seeing the entire investing universe as behemoth indexes moving their component parts around in lock-step. Ask me where stocks are going and I have a strong opinion. Ask about an individual company’s shares and I haven’t a clue. I wonder how many people with ruble or lira longs saw the carry as “compelling” and jumped in having asked, “What do you think about emerging markets?”

Being right on where the market is going shouldn’t be a burden placed on the shoulders of economists. They should be expected to be smart. And able to lay out the facts clearly. Traders are the ones who should have to figure out what it all translates into. CFTC data is something an economist shouldn’t be concerned with. And traders have a right to expect the economist to know how the numbers, big and small, are trending. It may be an unrealistic economic proposition given current constraints but the lack of distinction of responsibilities isn’t a step in the right direction…

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