Is Turkey the First Domino?

01/31/2014 12:01 am EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

The surprisingly large increase in Turkish interest rates makes MoneyShow's Jim Jubak wonder if it will have a domino effect on the other emerging markets.

For the week ahead, I think the thing you should watch is to see whether the action of Turkey's Central Bank, on January 28, sets a whole new wave of emerging market turmoil into place. Turkey's Central Bank has been under intense political pressure, for months, not to raise interest rates. The president of Turkey has come out and talked about an international cabal of countries that want Turkey to slow its economy and raise interest rates.

The last time the Central Bank visited this issue, they didn't raise rates; they did, kind of, a back-door finagling to try to get inflation under control, as well as, the real big problem in Turkey is that they have a sinking currency, because they have a huge balance of payments problem. This isn't working. The Turkish lira has been sinking like, well, a stone, or whatever, into the Bosphorus. On the 28th, they decided they were finally going to raise their benchmark rates.

In Turkey, the interest rate benchmark is the repo rate, so it's a short-term, overnight bank-to-bank rate. The Central Bank raised it from 4.5% to 10%; a huge move. It's clearly designed to make the markets go, “Ohhh” and stop sinking the lira. The lira, in fact, rallied after that.

The question is now, one of the fears that the market has had is that, of these kinds of interest rates hikes, that Brazil was going to have to do it, Turkey was going to have to do it. The whole idea is that you need to protect your currency in a country where you're running a current account deficit, so that you need to attract dollars to make your economy go; that's the problem.

When your currency is sinking like a stone and your interest rates are not very high, nobody wants to put dollars into your country, and therefore, everything goes down and there are worries about being able to sustain growth, and worries about credit, “blah, blah, blah.”

Turkey moved; now the question is will Brazil move? I think the answer is probably yes. The Central Bank of Brazil was talking, the day before Turkey's action, about the need to raise rates to defend the real, to get inflation under control, etc., so I think Brazil will follow. The worry here, of course, is if the markets look at this and go okay, we're not concerned that this is going to solve the problem because what it's going to do is slow these economies, which means they'll be producing less, which means that unless you get a lot fewer imports and your exports fall, you still have the balance of payments problems. Is this really going to solve the problem, or are we going to see these currencies stop plunging, or are we, basically, just going to have the markets go, “Okay, now Brazil is going to grow at an even slower rate, we like Brazil even less, and, therefore, we're going to continue to take money out of the real.” What to watch over the next week is who follows Turkey's lead and what the market reaction is, because the market basically says, “Okay, so, we'll let the currencies rally for a day or two and then resume to sell off.” I think we're talking about another extension, another shoe falling in the centipede that is the emerging markets currency sell off.

This is Jim Jubak for the MoneyShow.com video network.

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