The question of “Where is the tipping point for Turkey?” became that much more acute on August 2 as the market absorbed the impact of the US sanctioning two Turkish ministers in response to Ankara’s refusal to arrange the release of pastor Andrew Brunson. The unprecedented move by Washington against a fellow Nato member pushed the Turkish lira (TRY) to a fresh record low of 5.0934 against the dollar as the betting on Turkey’s overheating economy experiencing a hard landing intensified.

The currency was trading at 5.0612 as of around 17:30 local time, a decline of more than 1.3% d/d. Before the announcement of sanctions the TRY had never weakened beyond the psychological threshold of 5 to the USD.

Traders are pinning hopes on an August 3 between US Secretary of State Mike Pompeo and Turkish Foreign Minister Mevlut Cavusoglu in Singapore on the sidelines of an Asean summit in Singapore producing a breakthrough in the Brunson matter. But an unnamed banker told Reuters on August 2 that if the meeting failed to produce the desired results and the US adds to its sanctions on Turkey, a TRY rate of 5.30 or worse to the dollar could be seen.

The sanctions move, which specifically penalised Minister of Justice Abdulhamit Gul and Minister of Interior Suleyman Soylu, also hit Turkey’s 10-year domestic bond yield. It tested a new high of 19.48% on August 2, after closing the previous day at 18.59%. Two-year benchmark domestic paper saw 22.09%, up from 21.06% the day before.

The cost of insuring debt in Turkey climbed to the highest level seen since January 2012. Credit default swaps (CDS) rose to 348bp on August 2 from 333bp on August 1.

The Istanbul stock exchange’s benchmark BIST-100 was down 3.02% to 94,274. Despite all the woes, with analysts warning a currency-and-debt crisis may lie ahead, the stock market was generally seen as standing relatively solid on the day, but it has lost 22% from the record high level of 121,531.5 it saw on January 29. The index fell as low as 88,169 on July 12 during the turbulence that came after the cabinet reshuffle announced by the new executive presidency on July 9. Some analysts now see Turkish stocks as cheap but volatile.

Lurching market
“The market lurches from one negative event to another,” Nigel Rendell of Medley Global Advisors told Bloomberg. “The net result being the erosion of foreign appetite for Turkish assets and an ever weaker lira.”

“The sanctions imposed by the US on two Turkish government ministers in themselves aren’t very big, but it looks likely that more measures will be announced. The lira is likely to fall further, strengthening the case for interest rate hikes. And given the context of Turkey’s large current account deficit and dependence on foreign capital inflows, there is a real risk of more severe macro stress,” Jason Tuvey of Capital Economics said in a research note.

Timothy Ash, at BlueBay Asset Management, noted that US Vice President Mike Pence described the sanctions as “harsh economic sanctions”, a remark which was “interesting as from the economics perspective they are not really, as neither minister is thought to have significant overseas assets.”

He added: “Importantly there were no sanctions on Turkish entities—no sanctions on Turkish borrowings as per Russian sanctions. This might reflect an understanding in the US Treasury just how fragile the Turkish economy is at present—push much harder and the outcome on the economy front could be extreme, with not much going back then in terms of Turkey-US relations.”

Ash said it was “absolutely remarkable” that the Trump administration had decided to sanction a Nato ally. “It will inevitably push Turkey towards the Russian and Iranian orbit and I think even raises questions over Turkey’s Nato membership. I think Turkey thought Nato membership gave it leverage but I think where it miscalculated is it failed to understand that [Donald] Trump sets a very low store on Nato so hardly appreciates Turkey’s membership therein.” Further escalation that saw a trading of sanctions might see Turkey close the Incirlik airbase and then limit cooperation with the US in Syria and Iraq and in terms of Washington’s sanctions campaign against Iran, Ash added.

Inflation battering ahead
On August 3, Turkish markets are expected to take their regular battering from the statistical institute’s (TUIK’s) inflation figures report. The market consensus is that Turkey’s annual inflation, standing at a 15-year high, has at least a bit further to rise.

Turkey’s annual consumer price inflation jumped from 12.15% in May to 15.39% in June, the TUIK announced on July 3.

A BloombergHT poll of 17 financial institutions predicted that inflation would quicken to 16.3% in July.

Meanwhile, expectations that the local elections will be brought forward to November this year from March 2019 are mounting. Turkey’s economic problems are expected to become more starting from October after the fruitful tourism season of this year ends and the US’ sanctions on Iran’s energy exports, scheduled to snap back on November 4, come into effect.

Early local polls would delay desired fiscal tightening but, at the same time, would provide markets with new hope given that there would be an expectation that orthodox economic policies would follow after the elections were over and done with.