By Jon Sindreu and Mike Bird
The Turkish lira plunged Friday on investor concerns that the country won't repay its debts, a shock that set off sharp falls in other emerging-market currencies, hit the euro and European banks, and pushed the dollar to a one-year high.
For months, investors have questioned Turkey's financial health, but the impact was limited to its domestic market. On Friday, those concerns spread beyond Turkey.
The turmoil intensified when President Recep Tayyip Erdogan said Turkey was engaged in an "economic war." President Trump shortly afterward said in a tweet that tariffs on Turkish aluminum and steel would be doubled amid a deepening diplomatic spat between the U.S. and its strategically important ally.
On Friday, the lira fell almost 14% against the U.S. dollar in European afternoon trading and 45% over the past 52 weeks -- the second-biggest decline for a Group of 20 currency over the past decade. The lira dropped more than 20% this week alone.
Turkish sovereign bonds also sold off, with yields on 10-year debt trading above 20%, compared with 19% Thursday and roughly 12% at the start of May.
Among Turkey's problems: the U.S. recently sanctioned two Turkish ministers because the country is holding an American pastor for what Washington believes are politically motivated reasons.
"Erdogan has single-handedly inflicted harm to Turkey to the point of extreme vulnerability, but [the U.S. doubling sanctions] is the straw that breaks the camel's back," said Jan Dehn, head of research at emerging-market investment manager Ashmore Group.
As the lira falls, it will become harder for Turkey to pay a large laps of debt denominated in other currencies. Turkey's external debt as a percentage of gross domestic product is above 50%, one of the highest among developing economies, and the ability of its foreign-reserve pot to meet those demands is one of the weakest, figures from the World Bank and the International Monetary Fund show.
The lira took its first dive early Friday following a Financial Times report that the European Central Bank was examining lenders' exposure to Turkey. Three banks named in the piece tumbled: Spain's BBVA SA fell 6.3%, France's BNP Paribas dropped 4.2% and Italy's UniCredit slid 4.3%.
Data from the Bank for International Settlements showed that lenders in Spain, France and Italy had the highest exposure to the Turkish economy at the end of the first quarter, adding up to $81 billion, $35 billion and $18 billion, respectively.
The ECB's concerns aren't too high at this point but it is in contact with eurozone banks about their exposure to Turkey, a person familiar with the matter said.
The Turkish currency later recouped some of its losses, but dropped again after Mr. Erdogan addressed a crowd of supporters, asking Turks to exchange "any dollars, any euros or gold" for the domestic currency to shore it up.
"If they have their dollars, but we have our people, our righteousness, and our God," Mr. Erdogan said a day earlier.
The selloff deepened further after Mr. Trump's tweet, as well as vague economic plans disclosed by Finance Minister Berat Albayrak, Mr. Erdogan's son-in-law. Investors say the Turkish government is unlikely to announce the measures needed to assuage markets, such as allowing the central bank to raise interest rates sharply or asking for an International Monetary Fund bailout.
"When you have an imminent shock you can't really address it without proving details, and [Mr. Albayrak's presentation] was super short on details," said Viktor Szabo, senior investment manager at Aberdeen Standard Investments.
Investors said Friday's moves were accentuated by thin trading. The differences between quoted prices to buy and sell lira was "wide enough to park a bus," said Paul McNamara, investment director for emerging-market debt at GAM International Management, meaning that a $10 million sale was enough to move the currency a full percentage point.
While fears of market contagion appeared contained, the sharp moves recalled for some investors previous episodes when trouble in countries such as China and Greece fed wider market anxiety. Emerging markets were already grappling with a stronger dollar and fears over U.S. sanctions hurting global trade.
The Stoxx Europe 600 index fell 1.1% Friday, and the euro dropped 1.1% against the dollar to its weakest level since July 2017. The S&P 500 shed 0.6%.
Some other emerging-market currencies also weakened, with the South African rand and the Hungarian forint falling 2.6% and 1.9%, respectively. The Russian ruble fell 0.9% and hit a two-year low.
By contrast, haven assets like the Japanese yen, as well as U.S. and German government bonds, gained amid the turmoil. The WSJ Dollar Index, a measure of the greenback's strength against a range of trading partners' currencies, rose 1%.
The broader impact of a weaker Turkish economy is expected to be relatively small. Carsten Hesse, economist at German bank Berenberg, said that even a 20% fall in eurozone exports to Turkey would only subtract only 0.1 percentage point from the bloc's growth.
Still, some fund managers say fears about Turkey could trigger outflows from other emerging-market countries and push the dollar even higher.
During the eurozone's sovereign-debt crisis between 2010 and 2015, concerns over the financial frailty of Greece hit markets world-wide. A limited depreciation of China's currency in 2015 also sparked stock market selloffs.
Charlie Robertson, global chief economist at Renaissance Capital, said that the longer-term "contagion effect" would be limited because Turkey has a small presence in the widely tracked MSCI Emerging Markets index, so investors exiting Turkey won't be forced to sell assets in other developing nations.
"There was a lot of empty language about the need to make things better, " said James Athey, a fund manager at Aberdeen Standard Investments.
Riva Gold, David Gauthier-Villars and Tom Fairless contributed to this article.
Write to Jon Sindreu at firstname.lastname@example.org and Mike Bird at Mike.Bird@wsj.com
(END) Dow Jones Newswires
August 10, 2018 13:25 ET (17:25 GMT)
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