Turkey has returned to financial market headlines following President Erdogan’s decision to fire the country’s hawkish central bank head on Saturday. The Turkish Lira tumbled 14% against the dollar as trading kicked off in Asia to become one of the worst performing emerging market currencies against the greenback this year. The reverberations were felt in Asian markets, particularly in Japan where the Nikkei 225 fell 2%. While there should not be a strong link between the Turkish Lira and Japanese equity markets, it is believed that retail traders in Japan hold significant leveraged long positions in the Lira as a carry trade. Hence, they have to cover these positions by selling equities in local markets.
Elsewhere, Asian stocks traded mixed with China’s Shanghai Composite and Shenzhen Component slightly up, while Hong Kong’s Hang Seng and South Korea’s Kospi have fallen into negative territory. This indicates the Turkish Lira slump will only have a limited impact on other high yielding emerging markets with no risk of wider contagion.
US equity futures are struggling for direction with the S&P 500 spending most of the Asian session between red and green. However, the Nasdaq 100 has gained following a six-basis point fall in US 10-year Treasury yields. Global investors will again be testing the appetite for US debt auctions following a rally of more than 60% in US 10-year yields over just seven weeks. A further spike in yields will bring more volatility and continued rotation into value stocks from growth stocks.
Long term interest rates may have risen for good reason as investors anticipate a strong US economic recovery ahead that could last for several years and brings with it inflation. However, this could also be the biggest threat for risk assets that have been benefiting from an extremely low interest rate environment since the beginning of the Covid-19 pandemic. Despite the recent surge in long term interest rates, they are still considered low when compared to historic averages and that’s why some high asset prices may still be justified at current levels with the Nasdaq 100 having fallen 7% from February’s peak. However, the higher the long-term interest rates go, the more difficult it becomes to justify these valuations.
Companies with the ability to pass on higher prices to customers are likely to be the ones that benefit most and should be overweighted in portfolios. These could be in the industrial, material, financials and commodity sectors.