Turkey: will it be a coup d'EM?

The S&P 500 halted its longest run of consecutive gains in four months on Friday and this week will decide whether this will be a minor blip on the path higher or whether this rally will reverse sharply.

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Turkey’s unsuccessful coup attempt over the weekend saw emerging market assets reverse sharply as news of it began to filter out. The Turkish lira lost 4.7% against the USD soon after the news broke. But since currency markets have reopened it has already pared this loss somewhat by gaining 1.4%.

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The bigger concern is that this could hit sentiment in emerging markets more broadly. ZAR, RUB, MXN and BRL all dropped after the coup reports. The main emerging market ETF, the iShares MSCI Emerging Markets Index (EEM), has gained 10.7% in the post-Brexit rebound. Understandably, a bit of a pullback may be in order in the wake of the Turkish coup, but the hunt for yield in this global low rate environment is likely to see funds flow back in into higher yielding EM assets. Some may be tempted to buy up Turkish assets on rapid reversal hopes, but there is a good case for the Turkish lira to continue to move lower from here. The financing of Turkey’s large current account deficit is reliant on sustained inflows of foreign capital, and if this begins to dry up over political instability concerns, the only logical step would be to devalue the currency.

To maximise the unpleasantness being experienced by emerging markets, the US dollar surged on Friday after a number of US economic data releases all beat market expectations. The DXY dollar index bounced 0.5% after US retail sales, industrial production and Core CPI all came in better than consensus forecasts.

US retail sales gained 0.5% month-on-month in June, far above the consensus estimate of 0.1% MoM. This seems to have been particularly boosted by strong gasoline sales. US 2Q consumption growth has been very strong and the Atlanta Fed GDPNow forecast is predicting 2.4% YoY growth for GDP.

US industrial production also grew 0.6% MoM, far above the 0.3% estimate. This was largely driven by a big jump in motor vehicle output with production ex-autos remaining relatively unchanged. Nonetheless, what is being seen in capital goods orders and manufacturing PMIs all point to a noticeable recovery in the US industrial sector.

Asian markets do not seem to have been overly perturbed by the S&P 500’s negative close or news of the Turkish and Armenian coups, and all look set to open higher. The strength in the US dollar saw a lot of commodities pullback on Friday, which may stem some of the momentum that has been seen in the ASX materials space. But the solid performance of US financials on Friday in the wake of better than expected US economic data should help see some further buying in the Aussie banks.

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