Risk-off is in the cards

Is spread of the delta variant really going to get as bad as last autumn during the last wave when the vaccination campaign had not even started? I assume that another factor might be playing a role too: the end of fiscal supports. These helped to prevent a more pronounced collapse of the economy last year. However, these payments will be coming to an end in some cases starting in the autumn. It might only become clear at that stage to what extent the crisis might have caused more pronounced and possibly permanent damage. The unemployment rate might rise in some countries and a wave of bankruptcies might yet be looming. Combined with renewed, albeit less severe, pandemic restrictions, this might indeed constitute a severe blow to the economy. Even if things might not become as bad as that, a certain risk premium is likely to be justified at this stage. As a result, I at least would not bank on a rapid recovery from this current period of risk-off.


We have for many years looked at the Turkish lira through the prism of credit. Repeated credit expansions lifted growth, but at the cost of widening the current account deficit via rapid import growth. This current account deficit widening was at the root of the balance of payments’ sudden stop in August 2018, when the lira depreciated very sharply, and again in 2020 when a large credit expansion meant that the lira was among the weakest emerging market currencies that year. We are now tracking a sizable credit expansion that started in late May 2021 and is happening in lira-denominated loans. The size of this latest credit boom has already surpassed the Q1 2019 expansion ahead of municipal elections and is about half the size of the very large 2020 expansion at the height of the COVID shock. We revised our USD/TRY fair value to 9.50 from 7.50 in early May on weaker sentiment towards Turkey in global capital markets.

– Robin Brooks, economist, IIF, July 23


As the rise of U.S. Treasury yields stalled in the second quarter, the continued rally in the prices of most risky assets and commodities helped most EM currencies recover most of the ground they had lost earlier in the year. The trend reversed again in mid-June, when EM currencies fell sharply following the F•MC’s hawkish shift. And more recently, appetite for risk soured and U.S. Treasury yields dropped, amid growing concerns over the potential impact of the delta variant of COVID -19. Our view is that, on balance, these three factors – appetite for risk, U.S. Treasury yields, and commodity prices – point to further falls in most EM currencies over the second half of the year. While we still think that the global economic recovery will sustain appetite for risk, we expect U.S. Treasury yields to rise, which would put renewed pressure on EM currencies.

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