The Euro has had a fantastic second quarter this year. It rose from 1.08 against the USD and reached above 1.19 four months later.
Fueled by the Europeans issuing common debt, the rally seen in the Euro pairs is suddenly threatened by an unusual currency – the Turkish Lira. While Turkey has nothing to do with the European Union, the flows out of the Turkish Lira are enough to create troubles for the common currency.
Weak TRY Spells Troubles for the EUR
The Turkish Lira depreciated rapidly in the past weeks. During times of crisis, emerging markets’ currencies tend to underperform, especially against the world’s reserve currency – the USD.
Some signs of the rally in the USDTRY pair appeared for quite some time now. The draining USD liquidity seen in the last couple of months is usually a sign of trouble for emerging markets’ currencies. As the U.S. Treasury withdrew more USD than the Fed printed, the USD gained grounds against the TRY, among other emerging markets currencies.
The problem for the Euro comes from an unexpected player – the banking sector. Especially true in the South, the banking sector’s exposure to the Turkish economy and TRY is big enough to affect the common currency.
For instance, Spanish banks like the BBVA have direct exposure in Turkey, being affected by the ongoing depreciation of the TRY against the USD. Thus, the TRY depreciation hurts the BBVA business and, therefore the bottom line expressed in EUR. Hence, the EUR and the TRY have a direct relationship, with the latter influencing the former in the case of a sharp decline.
In other words, the more the USDTRY spikes, the more it will affect the EUR. Traders involved in financial markets during the 2008-2009 Great Financial Crisis know what happens when banks have too much exposure to different economies out of the common market. While the dependency of outside markets declined, the European banking system is still affected by the Turkish Lira’s performance.
Moving forward, two things are interesting to watch. First, the USDTRY rally may continue without the EURUSD to decline. As we have seen lately, the EURUSD reached above 1.19 while the USDTRY made new all-time highs.
Second, if the USD turns higher against other major currencies, it will also make a new high against emerging markets. This way, the EUR will suffer a double blow – one from a stronger USD and one from a weaker TRY.