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What do Turkey’s currency crisis, the return of political jitters to Italy, and the stalling or falling of prime global property markets – from Manhattan to Melbourne – all have in common?
If you’re a regular reader, you’ve probably guessed the answer already.
They are all happening because global monetary policy is getting tighter…
In yesterday’s Money Morning, we talked about the economic crisis in Turkey. We noted that in and of itself, Turkey was not a huge deal as far as the global economy goes.
Problem is, Turkey’s plight is the symptom of something deeper going on, that might be a much bigger deal for the global economy.
Things generally happen in markets for a reason. That reason might not be readily apparent to you at the time of the event, but that doesn’t mean that it has simply come out of the blue.
Let’s look at some apparently very separate financial events. Turkey’s currency crisis, for starters. Why now?
Sure, President Erdogan has thrown off any pretence of being a democratically-elected rational reformer, and is now just another ranting autocrat, who will do nothing but make his people’s lives miserable until his reign ends.
But we’ve known that for a while. Why now?
In Italy, government bond yields have hit their highest levels in two months (in other words, it’s become more expensive for Italy’s government to borrow money). I wouldn’t normally bother to take a note of that, except for the fact that it inspired a rather frantic reaction from the Italian government’s deputy prime minister, Matteo Salvini.
Echoing every other hysterical populist leader across the world, he framed the move in yields as an “attack” by some mysterious force, rather than the logical outcome of expecting people to lend you money while simultaneously treating them with no respect.
“If someone wants to use the markets against the government, it must know that we cannot be threatened.”
Sure, we all know that the real surprise is that Italian bond yields are as low as they are, given its reputation for economic competence. A gentle rise in its borrowing cost is hardly astonishing.
But we’ve known that for a while. So why’s it happening now?
And how about the slowdown in house prices across the globe? For example, this week we learned that Australia – the teflon economy – now has something that looks as though it could turn into a proper property crash on its hands. Prices in Sydney are now down 5.6% year on year – the sort of thing not seen since 2008.
Sure, prices have reached ridiculous levels in most major cities, with locals angry at being priced out, and politicians predictably pointing to rich foreigners as being the ones to blame.
But we’ve known that for a while. Lord knows I’ve been writing about it for years. So why now?
As money dries up, the riskiest investments suffer first
It is, of course, as we highlighted earlier, all down to tightening global monetary policy. As John Authers points out in his excellent daily newsletter for the FT, we’ve seen a version of the Turkey panic before.
Back in May 2013, the US signalled that it would begin the process of ending quantitative easing (QE). The so-called “taper” involved buying fewer and fewer bonds as the months went by, until the Fed had stopped injecting new money into markets altogether.
The market freaked out, to put it lightly. (Which was entirely to be expected, given that the only thing apparently holding everything together for the best part of five years had been QE.)
At that point – just as is happening now – investors started pulling out of emerging-market countries with high current account deficits.
The problem with a high current account deficit is that it means you are reliant on foreign money propping up your economy. Everyone knows that foreign money is often “hot” money – it’s fickle. It stays for as long as it’s getting a better return than at home, but flees at the first sign of danger. So if you are part of that “hot” money, it’s sensible to panic first and ask questions later.
That’s what happened. Turkey, Brazil, Indonesia, India and South Africa all saw their currencies slide against the US dollar. The same thing is happening right now – the problems in Turkey are spilling out to the same group of countries.
So, this isn’t about Turkey. It’s just that Turkey – and these other countries – happen to be among the fringe assets that are most vulnerable to rising interest rates in the US.
The same goes for Italy and other troubled eurozone states. The world knows that problems remain with all of these countries, and they have only been plastered over by the soothing balm of eurozone QE. What happens when that ends? The problems come back. So you better not be invested in the weakest eurozone credits when that happens.
Same goes for over-priced property across the world. We’ve already discussed the mechanics of how rising interest rates impact on property prices many times in Money Morning. Again, those assets that benefited most from low and falling interest rates are the ones that will suffer most now that rates are (still) low, but rising.
What does it mean for your money? Don’t race to dump anything – it’s easy to be indiscriminate, but so far the main impact on emerging markets, for example, has been on those that deserve to be weak (India is holding up better than most of the “fragile” countries mentioned above, for example).
But building a cash “buffer” is a good idea. All that means is having more cash in your portfolio than you’d normally have. It can sit there and be ready to pounce when and if bargains arise.
As Authers points out, the 2013 panic ended because the Fed decided to slow down its pace of “tapering”. It then stayed calm – at least until the Chinese currency panic in 2015 – because everyone was convinced that the Fed under Janet Yellen, would always take the market reaction into account. (And it’s worth noting that the Chinese currency panic of 2015 only ended because the Fed delayed acting once again.)
New Fed chief Jerome Powell has worked hard to reverse that view. It will be interesting to see how long he can hold out.