The Right Medicine? Turkey Hikes Interest Rates To Combat Financial Crisis

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by: Russell Investments

On the latest edition of Market Week in Review, Senior Investment Strategist Paul Eitelman and Consulting Director Sophie Antal Gilbert discussed the market impact of trade developments between the U.S. and China, steep interest-rate increases in Turkey, and the state of the U.S. banking sector 10 years after the collapse of Lehman Brothers.

Potential for renewed U.S.-China trade discussions moves markets

The sensitivity of financial markets in regard to trade was on display again the week of Sept. 10, Eitelman said, as incrementally positive news earlier in the week helped lead to gains in most major indexes. "Reports that the U.S. and China may potentially restart trade negotiations drove markets a bit higher," he said, noting that as of mid-morning Sept. 14, both the S&P 500® Index and the Euro STOXX 600® Index were up about 1% on the week, with the MSCI Emerging Markets Index up roughly 0.75%.

While there's no guarantee that another round of trade talks between the two countries will be successful, Eitelman believes that any future discussions could help open more pathways to a positive outcome, in addition to helping stave off a full-blown trade war.

Turkey announces steep interest-rate increases

Turning to emerging markets, Eitelman noted that the Turkish central bank sharply increased interest rates on Sept. 13, hiking borrowing costs by 6.25%. With Turkey mired in a currency crisis amid high inflation, this was a necessary move, he said. "This very steep rate increase is tough medicine, but it's the right medicine," Eitelman remarked, "as we believe Turkey needs to impose high rates in order to tackle its inflation problem and hopefully stem the capital outflows that have been occurring this year."

Given that Turkey's financial crisis has been a recent catalyst for uncertainty in emerging markets, Eitelman believes that the rate increases should be viewed as a positive for the asset class as a whole. However, he cautioned that this doesn't mean the coast is necessarily clear going forward. "Trade issues between the U.S. and other countries are still a major source of uncertainty for emerging markets, as this class is a big driver of global trade," he emphasized.

Lehman Brothers, 10 years later: Are U.S. banks on firmer footing?

The 10-year anniversary of the collapse of Lehman Brothers is Sept. 15, Eitelman said. In the decade since, the U.S. banking sector has made several positive strides in improving its financial stability, he noted. "One way to measure this is to look at tier 1 capital ratios-essentially, the percentage of safe assets that banks hold on their balance sheets," he explained. Back in 2007, the ratio for U.S. banks was around 9%, whereas today it's closer to 13%, Eitelman said.

In addition, from his vantage point, U.S. banks have been much more prudent with how they've lent money. "This is particularly true on the mortgage side, where banks have been quite strict when it comes to documentation and ensuring the credit quality of borrowers," he stated. This, in turn, helps boost not only the stability of the financial system but also the economy at large, Eitelman said - because stress in the banking system is what typically turns a normal recession into a crisis. "Even though we could potentially experience a recession in the U.S. in the next couple of years, the health of the banking system, in my opinion, is at least one positive that should prevent a really bad outcome, like in 2008-09," he concluded.

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