The Eagle against the PICTS

When I travelled to England to watch my beloved Beşiktaş against Liverpool, I drove as far north as Hadrian’s Wall, which was built by the Romans in the second century as a defensive fortification. Another eagle is again on a collision course with Picts nearly two millennia later.

As the Fed’s first rate hike in almost a decade approaches, financial markets remain uncomfortably numb: The VIX index, a measure of the implied volatility of U.S. stock options often touted as the markets’ fear gauge, is at historically low levels. Many believe that the Fed rate hike has already been priced in and therefore will be a non-event.


This may be the calm before the storm. As economists from French bank BNP Paribas underline in a recent research note, “academic research consistently finds that sharp spikes in the VIX are the biggest single driver of emerging market (EM) financial stress.” They therefore try to figure out which EMs would be most vulnerable to such a surge in volatility following the Fed’s hike.

In doing so, rather than looking vulnerability indicators in an absolute sense, they rank sixteen EMs according to “ten key indicators encompassing macro momentum, policy space, external liquidity and solvency.” This methodology makes sense when you consider that markets are like a beauty contest.

The ugliest turns out to be Colombia, whose current account balance has deteriorated significantly because of lower oil prices, followed by two members of the original “fragile five”: Turkey and Indonesia. The other vulnerable countries turn out to be South Africa and Peru, forming the new fragile five as “PICTS.”

For Turkey, BNP Paribas economists note that “despite a more than 3 percent of GDP improvement in its current account position since the taper tantrum, extremely high external financing requirements and reliance on hot money stands out as Turkey’s main Achilles Heel. High, above-target inflation fed by a drip-feed of TRY depreciation is a further complication, cramping policy space.”

Their methodology may actually be underestimating Turkey’s vulnerability: “Uncertain politics, necessarily not captured here, are another, more recent fault-line.” That’s why the coalition talks, which are officially supposed to start after President Recep Tayyip Erdoğan gives the mandate to form the government to Prime Minister Ahmet Davutoğlu once the parliamentary speaker is elected, are extremely important.

To make matters worse, a coalition is heavily priced in, while early elections are not. In fact, the markets’ expectation of the goldilocks scenario of a grand coalition between the Justice and Development (AKP) and Republican People’s (CHP) parties, which got two thirds of the votes, has risen despite CHP leader Kemal Kılıçdaroğlu’s recent remarks giving such a coalition only a slim chance.

Işık Ökte, strategist at BNP Paribas’ Turkey affiliate TEB Investment, believes that Turkey’s credit ratings may be downgraded to non-investment grade, and Turkish assets hit far worse than during the Gezi protests, if the coalition talks fail and Erdoğan calls for early elections, perhaps only too willingly.

BNP Paribas analysts imply that if the country is without a government and preparing for early elections when the American Eagle strikes with a rate hike in September, the first of the PICTS to fall may be Turkey. And if the shock is large enough, it may even be roasted by Thanksgiving.