Blog Posts — August 27, 2018

US Interest Rate Increase Hits Emerging Markets, But None More Than Turkey

As seen in the Taper Tantrum of 2013[1], emerging markets are the first to get hurt when the US raises interest rates. This is particularly true for those emerging countries with large USD denominated debt and current account deficits, such as Turkey. For emerging markets issuing debt in USD, Axioma’s fixed income risk model computes a separate sovereign spread factor over the US sovereign curve (distinct from the local currency sovereign curve of that country), representing the risk premium over the 5-Year Treasury bond for that country to USD investors. So, if investors require a yield of 2.73% for holding on to 5-Year US Treasuries on August 13, they required another 6.9% to hold on to Turkish USD-denominated debt of the same tenure! That has since come down to a 5.4% premium, but to put that into perspective, investors required only an additional 3% yield at the height of the Taper Tantrum crisis[2].

The chart below shows the USD Sovereign Spread for Turkey from January 4, 2013 to August 23, 2018 and highlights the jump in the risk premium caused by the Taper Tantrum in Q2 2013 and the recent crisis. Turkey, it seems, is a lot more sensitive to the political implications of a jailed US pastor than it is to US interest rates, giving a different meaning to the separation of Church and State…

Turkey isn’t the only emerging market that investors decided was ripe for some additional roasting, having been weakened by the realities of higher US interest rates, a stronger USD and falling commodity prices. Below is a year-to-date chart for the USD sovereign premiums of Mexico, Russia, Indonesia, South Africa and Brazil. To be fair, Turkey (the only NATO ally on the list) was always trading at a premium to this group, even to Russia (NATO’s number-one adversary), but all show a marked sensitivity to ‘foreign-relations-by-Twitter’ this year and the imposition of additional sanctions (e.g. Russia). 

Overall, Turkey has recently paid a hefty risk premium of 3.88% on its USD debt, above and beyond what investors required of it at the peak of the taper tantrum. In contrast, the sovereign USD risk premiums for Indonesia, Mexico, South Africa and Russia have fallen, and that of Brazil only added 20 bps. One wonders if Turkey might have received a discount had it imprisoned Robert Mueller instead…

[1] Taper Tantrum is a term used to refer to the Federal Reserve’s use of tapering to gradually unwind its QE program. It occurred between April 19 and June 18, 2013.

[2] On June 24 2013, the Turkey USD Sovereign Spread was 2.97%