Why Turkish turbulence hasn’t tainted EMD

Without a doubt, the main event in emerging market debt (EMD) last week came from Turkey, said Alejandro Arevalo, Head of Emerging Market Debt. The key thing is volatility didn’t spread to other parts of the market, showing the increased resilience of the asset class today.


To recap, in November, President Erdogan announced he wanted to start a new period of economic reform, appointing Naci Agbal as central bank governor, and removing the president’s son-in-law as the minister of finance and economy. In Erdogan’s own words, he wanted to “prioritise price and financial stability”.


Agbal wanted to achieve four goals: to build policy credibility, reduce inflation, reverse dollarization, and deliver FX reserves – and he surprised the market by delivering. Agbal tightened the benchmark rate by 875bps in four months; Turkey saw more than $10bn inflows during the period; Fitch revised its outlook to stable in February; and the Turkish lira appreciated more than 20% during that time.


But, in March, Agbal’s last 200bps hike (100bps higher than the market expected) apparently proved too much for Erdogan. Two days later, Erdogan announced he had replaced Agbal with close ally and critic of tight monetary policy Sahap Kavcioglu; someone who believes, along with Erdogan, that higher interest rates indirectly cause inflation, and that the lira had been kept too strong.


The ousting caught investors by surprise, and now general expectations are that Turkey is going back to its old ways. Questions are being raised again about the size of its FX reserves and its external liabilities. FX has already dropped by around 10%, and there are expectations for further falls. While the central bank and state-owned banks are trying to stabilise the market, everyone knows that’s not sustainable, said Alejandro; they will run out of reserves before anything can be achieved.


Kavcioglu has not commented publicly, although, interestingly, he put out written responses to some Bloomberg questions. Those responses only spooked the market further, as he said that when the central bank meets again in April, a 200bps cut is not out of the question.


Positively, in terms of wider emerging markets Alejandro highlighted how we haven’t seen any contagion from Turkey – it was a very isolated event. This underlines how EMD as an asset class has changed in the last ten years: quality has improved, fiscal responsibility has increased, and contagion is much less of a risk. The key driver of weakness in 2021 has been rising US rates, and even there EMD has shown more resilience than many other areas of fixed income.


Alejandro said there’s a huge amount of cash on the sidelines waiting to be put to work. Last week we saw a return to inflows into the EMD asset class, and the new issue pipeline remains exciting. Investors still want to chase yield, and they are beginning to learn that it’s vital to differentiate between EM stories. Overall, the picture for EM is still very positive, and given its higher yield and improving quality, it’s extremely hard to ignore the asset class.


A warning note on China

Jason Pidcock, Head of Strategy, Asian Income, was optimistic about the profitability of many Asian companies in 2021, but he sounded a warning note over geopolitical risk around China.


He cautioned that China has become politically isolated. The new administration in the US has been focused on COVID, but President Biden has also signalled a tough line on China. Biden recently called China “our most serious competitor” and pledged “to confront China’s economic abuses and counter its aggressive, coercive actions, and push back on China’s attack on human rights and intellectual property and global governance”.


The rumblings, so far primarily diplomatic, have had some economic and market fallout. Jason said that investors should consider the possibility of an eventual escalation to some form of Chinese military action in relation to Taiwan, territory long claimed by the People’s Republic. Taiwan is home to many of the world’s leading electronics and semiconductor companies, whose clients include large Western companies. Any possible Taiwan crisis in future would be globally destabilising. Absent these geopolitical risks, however, Jason predicts a bright business future for Taiwan, highlighting electronics for electric vehicles as just one growth area.


He also pointed out that when it when it comes to overseas adventures, China is typically cautious, unlike Russia which likes to take tactical advantage of perceived windows of opportunity. Jason argued that the Chinese Communist Party is well aware of the risks of military adventures. Were China to gamble on Taiwan and fail, there could be wholesale political change, with the Communist Party losing power. Jason believes the Communist Party is likely to take a pragmatic approach.


Jason said that it is sensible to be diversified and suggested that if investors increasingly fear geopolitical risk around China, countries more distant to China, such as India and Australia, could be beneficiaries.


Diversification within environmental investing is key

Finding environmental solutions companies that are slightly off the radar has never been more important, said Jon Wallace, fund manager in the Environmental Solutions team.


Pockets of the environmental markets universe have come under fire recently for displaying ‘green bubble’-like behaviour. In the case of the clean energy and sustainable mobility sectors, this was fairly justified over the first quarter. However, the environmental investing universe is vast: in this environment, opportunities in sectors such as the circular economy presented themselves, including an interesting company that commercialises biomaterials, to use just one example. Within the environmental solutions strategy at Jupiter, the team use seven broad themes to allow investors to access the full breadth and depth of environmental markets. Given better value could be found elsewhere in this diverse opportunity set, exposure to clean energy is at its lowest in the last three years.

Please note

Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.

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