by Connor Darrell, Head of Investments
Economic turmoil in Turkey weighed down markets last week, as the nation’s leadership has come under criticism for failing to properly manage its growing debt burden and plummeting currency. There are now increasing concerns that Turkey’s financial instability could lead to higher default rates on loans from European banks, which could have ripple effects throughout global markets. Turkey’s problems were exacerbated by escalating diplomatic and economic tensions with the United States, which have led to threats of further retaliatory action in response to Turkey’s detainment of a U.S. pastor on charges of espionage.

The uncertainty led to a selloff in the S&P 500 on Friday that erased the week’s gains. International markets were hit a bit harder.  Elsewhere, the U.S. bond market pushed higher as investors sought the relative safety of U.S. Treasuries.

Turkish Turmoil Worth Watching, But Long-Term Impacts Negligible
The fears of “contagion” emanating from the turmoil in Turkey have been brewing for several months now, but are ultimately unlikely to have a lasting, meaningful impact on the U.S. economy. The primary concern from a global perspective is that Turkish borrowers will find it much more difficult to repay their debts as the currency continues to decline. However, the reality is that while some pain could certainly be felt by rising default rates in Turkey, the Turkish economy is not large enough for an isolated crisis to have a sustained impact on a global scale. Turkish stocks make up only about 0.7% of a market cap weighted Emerging Markets Index, which is itself only a small fraction of global equity markets. U.S. investors are thus very unlikely to have meaningful exposure to Turkish assets (if any at all). There is an old market adage suggesting that “when the U.S. sneezes, the world catches a cold.” Fortunately, the adage does not apply to the Turkish economy.

The problems in Turkey do however serve as a reminder of the importance of sound economic policy. Many economists believe that the Turkish government should bare much of the blame for its current predicament, as it has exerted pressure on the nation’s central bank to prevent it from raising interest rates; a move that many believe could help to stave off inflation and stabilize the currency. The role that central banks now play in maintaining global financial stability has grown considerably over the past decade or so and is particularly relevant here in the United States as the Federal Reserve moves forward with its tightening process.