The financial community woke up on Monday morning only to see gaps open in the currency market. Because this is the most liquid market in the world, gaps rarely form, and if they do, that happens over the weekend.
News is responsible for gap formation. Such news typically belongs to referendums or elections, often held Saturdays and Sundays. When the outcome differs from what markets expected, the main currency pairs open with a gap.
Sometimes, however, other events are so bizarre that the market immediately reprices the exchange rates seen at the close of the previous week. Such an event happened last weekend – the Turkish President, Erdogan, replaced the central bank chief.
Emerging Markets’ Stability Under Pressure
The local currency, the Turkish lira (TRY), was under pressure for most of 2020. While the U.S. dollar lost ground in the second half of last year, as investors reacted to the main central banks’ monetary policy decisions, the greenback’s gains against the lira continued.
That trend lower in the lira ended by the time Naci Agbal, the now former Governor of the Turkish Central Bank, was appointed to the job. Financial markets regained confidence that Turkey is on the right track, and flows started to pour into emerging markets from the investing community.
It all came to an abrupt halt this week. The Turkish President’s decision was so surprising that even the major FX pairs reacted, not only the TRY pair. To exemplify, the EURUSD pair gapped about thirty pips points, and so did the AUDUSD. How about the TRY?
Effectively overnight, the TRY lost all the gains from the last few several months since the new Governor was appointed. Moreover, the Turkey 10-year bond yield rose an impressive four-hundred basis points, a move destined to affect the trust in other emerging markets.
Suddenly, the decision had ripple effects for the Turkish economy and for other emerging markets. To start with, it is more expensive for Turkey now to borrow from the international financial markets, as reflected by the jump in the yields.
Moreover, the slump in the lira and the rise in the yields led to a decline in the stock market. Effectively, investors pulled out funds in a hurry due to the increased uncertainty.
The rout on the local market had such a big impact that two days later, the Turkish President urged Turks to invest their gold and FX reserves into financial instruments denominated in TRY. If that’s going to be the case, it remains to be seen because it is not the first time when Erdogan appeals to Turks, and last time it was to the detriment of those that listened to him.