All focus is on Turkey right now as their currency goes into freefall and 5-year credit default swaps (insurance against default) have now spiked to levels last seen during the 2008-2009 financial crisis.
Source: Bloomberg, Financial Sense® Wealth Management. Past performance is no guarantee of future results.
Emerging market risks accelerated with an inversion in the corporate yield curve along with the unwind in quantitative easing, which projected emerging market outflows accelerating into the second half of this year.
Is Turkey the Next Bear Stearns?
Russell Napier, co-founder of the Electronic Research Interchange, warned on our podcast in 2015 that Turkey is equivalent to Bear Stearns in terms of risk. Here's what he had to say:
"Just to put it in context: the amount of money borrowed by Turkey is similar to the amount of money that was borrowed by Bear Stearns—it's about $400 billion. Bear Stearns of course had off-sheet liabilities as well, but on-sheet liabilities of $400 billion. Lehman Brothers was $600 billion, so that puts it in context. This is a big number and it's lent from outside the system so it does have issues for financial stability, particularly in Europe and we need to make that clear."
Possible Trigger for EM Crisis, Wider Outlows
"People think Turkey is not important and I've mentioned the scale of why it's important, but the crucial reason is the knock-on effect of capital flows into other emerging markets. That's always been an issue when a big one has gotten in trouble. The reason it's more of an issue today is that the debt capital provided to emerging markets historically came from banks and they may have been capable of distinguishing one country from another and saying, 'Just because Turkey has problems I won't pull my capital from the Philippines,' but today a significant portion of EM debt capital is provided by bond investors. And quite a proportion of that is provided by pension funds but, sadly, a very, very large proportion is also provided by open-ended funds which can get redemptions. So, Turkey is going to be about 15% of the money that any open-ended emerging market bond fund has invested and I think it will make the front page of the newspapers and potentially trigger redemptions from these funds and capital coming out of the [emerging market space.] So, as I mentioned at the beginning, it tends to be that the emerging market cycle ends with a bang and not a whimper and Turkey like Thailand in 1997 may be the trigger for wider capital outflows."