(Bloomberg) -- Donald Trump’s recent act as the good cop of Turkey’s markets is drowning out President Recep Tayyip Erdogan’s stunning dismissal of the central bank governor over the weekend.
With a sophisticated Russian missile-defense system arriving in Turkey as early as this week, the U.S. leader’s suggestion that he may spare it the worst of sanctions is helping prop up the country’s market after Erdogan’s latest assault on monetary policy making. Without a reprieve from Trump, the deal with Moscow could trigger penalties that include options some American officials believe would all but cripple the Turkish economy.
By putting into question the central bank’s resolve to backstop the nation’s assets, the shock reshuffle briefly cost the lira its spot as the world’s best performer this month. The currency had been on a tear after Trump suggested at the Group of 20 meeting in Japan in June that he would reassess his threat to sanction America’s NATO ally.
For now, “the market is pricing no or mild sanctions, mostly on the basis of post-G20 statements,” said Paul McNamara, a money manager at GAM UK, who helps oversee $9.4 billion in assets and has a small overweight position in Turkish bonds and the lira. But “it’s no longer sensible to hope for the best. They’re set to snatch defeat from the jaws of victory.”
The wait for missiles to arrive is nearly over, but what happens next will depend in large part on Trump, who has the authority to select from a menu of measures under the Countering America’s Adversaries Through Sanctions Act. The U.S. fears that Turkey’s pivot to Moscow could allow Russia to collect critical intelligence that would weaken NATO and compromise the American F-35 stealth fighter.
It remains unclear if the trigger would be the delivery or the activation of Russian military hardware. Erdogan has placed all his chips on lobbying the U.S. leader directly, believing that their personal rapport will ward off the worst.
Collision Ahead?
Much like the wrangling over a detained U.S. pastor last year that saw Turkey’s currency shed almost a third of its value and bank valuations drop to less than half their book value, the worry for investors is the prospect of another standoff.
Although the nation’s high-yielding assets are ripe for a rebound, another round of punishment could set back Turkey’s fragile economic recovery, and the possibility of financial sanctions that would affect debt sales or transactions with U.S. institutions.
“We need to see what the real sanctions extent would be in order to gather what to price if it happens,” Ogeday Topcular and Mete Sarper, fund managers at RAM Capital, said in an emailed note.
Economic Buffer
What makes this standoff different, argue the bulls, is that the economy is less of a liability after experiencing a hefty adjustment, thus limiting the scope for another meltdown. Turkey’s first recession in a decade has narrowed the current-account deficit, inflation is set to slow sharply over the coming months, and the central bank is gearing up for an easing cycle.
“We invest our money based on how the economy is doing,” said Ekaterina Iliouchenko, a portfolio manager at Union Investment Privatfonds Gmbh. “I don’t think Turkey will be cut from financial markets. A lot of investors are paying too much attention to these issues, but in the end it’s always back to economic fundamentals.”