As Dollar Fights Back, Can Flash PMIs Revive Euro and Pound Rally?

Youssef Hamidi was a central defender in the Aleppo University football team before fleeing the city to Turkey a decade ago, whereafter much of his hometown was reduced to rubble by Syrian and Russian bombing.

His athletic physique helped him cope with the demands of a job he found as a clothes presser on a ready-wear production line in the southern Turkish city of Gaziantep.

The hard work was the first step in his transformation from an engineering student unable to complete his degree, to the owner of an unregistered, underground clothes factory.

He is one of many Syrian refugees who form a large proportion of the black economy of Gaziantep. Some have unlicensed businesses, while most work as labourers.

"Low cost is a major reason why I charge less and receive enough orders," says MR. Hamidi from his factory, just outside the old centre of Gaziantep. The city, one of Turkey's industrial centres, was historically part of the hinterland of the famed Silk Road metropolis of Aleppo.

Hamidi's factory does mainly subcontract work for large Turkish factories and employs 30 Syrians. But lack of official paperwork has curbed potential for expansion and deprived the workers of benefits.

Political uncertainty over the fate of the refugees has increased since an earthquake struck south Turkey in February and prompted increased resentment against them as economic pressures rose and the value of the lira plummeted.

Turkey stopped letting in new refugees from Syria in 2016, having taken in 3.5 million after the crackdown on the 2011 revolt against President Bashar Al Assad, and the ensuing civil war. Businesses can employ Syrian refugees, if a ratio is maintained with Turkish workers.

After his election victory In May, President Reccep Tayep Erdogan repeated a promise to return one million Syrian refugees to areas held by opponents of MR. Al Assad on the border with Turkey.

Hamidi says that he feels stuck, having learnt Turkish and built a network that could help him grow his business.

Even if he registers his factory, employment restrictions will not allow him to keep all his Syrian staff, whom he says are afraid to be officially identified. Taxes and contributions he would have to pay on behalf of the workers would also deprive him of a crucial cost advantage, he says.

"The Turkish government knows about us and is leaving us be. I don't know till when," he says.

For almost a year after he arrived in Turkey, MR. Hamidi ironed finished clothes before the packaging stage on the production line.

He advanced to work with an electric blade that cuts cloth in bulk, and can inflict serious injuries to the person operating it at the slightest slip.

One day, the workshop owner saw MR. Hamidi operating the machine by switching between his two hands, which made him faster than other workers.

"Co-ordination is a skill I got from football," says the bald, bespectacled MR. Hamidi, who is 31.

He ended up learning all aspects of ready-wear manufacturing, even mastering design, using a computer programme. Large factories in Gaziantep have mass produced dresses and sportswear of his own design.

He and his staff work in cramped conditions in the large basement of a building, cutting and joining textiles for bigger manufacturers in the city.

"I love my work so much that I don't feel that I am spending 12 hours a day here," says MR. Hamidi, who does not take any days of the week off and still has time to play football.

He also coaches children in a programme run by a nearby municipality.

About half of the of 2.2 million working-age Syrian refugees in Turkey last year had some form of work, mostly informally in menial jobs, figures by the International Labour Organisation show.

Some refugees, however, have gone into more high-tech businesses.

Among them is Ahmad Haykal, who was supposed to sit for his high school exam in 2013, when the half of the city he lives in fell to rebels. He fled to Turkey after Russian intervention allowed the regime to recapture Aleppo in 2016.

While growing up in Aleppo, MR. Haykal used to go to a workshop owned by his family and tinker with large inverters and other electrical equipment.

His late father used to import electrical parts for industrial infrastructure as scrap from factories that went out of business in Europe and resell them after repairing and overhauling the equipment.

In Gaziantep he opened a similar business after putting together a network of scouts who would identify disused factories in Turkey or those on the verge of closing.

"I don't think that such a business model existed before I came to Turkey," says MR. Haykal, at his shop on a busy street in Gaziantep.

He is surrounded by piles of giant electrical equipment, made by Schneider, ABB and Siemens. The parts look as good as new after being overhauled by MR. Haykal and his team of Syrian technicians.

One part costs $3,000 new. MR. Haykal sells it for $300. Apart from the lure of the price, MR. Haykal says the old parts are better made.

He wants to obtain Turkish citizenship because it would enable him to travel to Europe to buy stock, similar to his father.

But he says obtaining a second nationality is becoming a distant dream, with the threat of deportation rising.

"I cannot invest to streamline the business in these conditions," he says. "It has been one step forward, two steps back."

Over the past several weeks, Turkey has forcibly returned hundreds of refugees, according to reports by Syrian media opposed to MR. Al Assad.

Saad, a Syrian businessman who owns, with Turkish partners, a licensed processed food factory in Gaziantep, says an underground mentality has been instilled in Syrians since the Assad family took power in 1970.

Saad, who did not want to his last name revealed, is also contracted by a western aid organisation to encourage Syrian business owners in Turkey to register with the government.

He says legitimising the Syrian businesses would shield workers and owners against deportation.

"All their life in Syria they have been afraid that an arbitrary power will come after them if they declare what they have," he says. "I don't think this is the case in Turkey."

Turkey overtook Germany and Poland to become Europe's top coal-fired electricity producer in June, and for the opening half of 2023 generated more coal power than Poland for the first time to emerge as Europe's second-largest coal user behind Germany.

Turkey's first-half coal generation was the highest total for the opening half of a year since at least 2018, and contrasts with steady declines in coal-fired power seen in Germany, Poland and elsewhere across Europe in recent years, data from Ember shows.

Emissions from Turkey's coal-fired electricity output also hit a new half-year high in the opening half of 2023, topping 44 million tonnes of carbon dioxide and equivalent gases.

That emissions toll surpassed Poland's 39 million tonnes for the same period, and elevates Turkey as a major source of coal pollution in Southern Europe that may soon eclipse Eastern Europe as the main hub for industrial emissions in the region.

Turkey's steady climb in coal-fired electricity output is in line with its coal generation capacity, which has increased in 9 of the past 10 years to 20.49 gigawatts as of the end of 2022.

Since 2018, Turkey's installed coal capacity has climbed by more than 9%, which compares with declines of more than 15% in Germany, 20% in Italy, 44% in Romania, and 14% in the Czech Republic over the same period. Even Poland, Europe's most coal-dependent economy, has seen a modest net capacity decline since 2018.

Turkey is also forging a rare path by increasing coal's share of its electricity generation mix, to nearly 36% for the opening half of 2023, compared with almost universal reductions in coal use elsewhere in Europe.

While Turkey appears to be heading down a lonely path in terms of increasing coal dependence, it has made important advances in clean power development in recent years, including a more than 80% increase in generation from wind and solar sources.

Indeed, Turkey's electricity generation from all clean sources has risen by 40% since 2018, while generation from fossil fuels declined by more than 8% over that period.

However, electricity generation from natural gas accounted for a majority of the decline in fossil output, dropping by 18% from 2018 until 2022, due in large part to the spikes in global natural gas prices during that period and the recent disruption to gas flows following Russia's invasion of Ukraine last year.

In turn, this has forced Turkey's utilities to alter the generation mix, cutting natural gas's share of the mix from 37% in 2017 to 23% last year.

To make up for the loss in dispatchable base load power generated from gas, utilities in Turkey have been forced to increase use of coal, which has seen its share of the generation mix climb from about 32% in 2017 to more than 34% in 2022.

Coal's share rose to nearly 37% in June of this year as Turkey cranked coal generation to make up for a drop in gas-fired output to its lowest level since mid-2020, when much of the global economy was stalled by COVID-19 lockdowns.

Coal's share may climb higher still as overall power demand rises amid an enduring heatwave that has triggered a spike in demand for power-hungry air conditioners throughout the country's south and west.

Further increases in coal-fired generation may in turn push Turkey farther ahead of Poland in terms of coal generation over the near term, and potentially narrow the gap more on Europe's top coal user, Germany.

Over the longer run, however, Turkey has ambitions to boost solar power capacity by fivefold and wind supply capacity threefold by 2035 in an effort to decarbonise its power sector and become more energy independent, according to Enerdata.

That should undermine coal's usage momentum in Turkey's energy system, and potentially result in Turkey making only a fleeting entry as one of Europe's main coal users.

Earlier this week, Russia announced that it would suspend its participation in the Black Sea Grain Initiative, the landmark diplomatic deal brokered by the United Nations and Türkiye that allowed for the resumption of agricultural exports after the Russian naval blockade of key maritime routes following its invasion of Ukraine.

The contribution that this agreement has made to global food security cannot be overstated - facilitating exports of essential food and fertilisers from Ukraine and Russia and reducing global food prices by around a quarter since March last year.

Critically, grain shipped through the Black Sea also played a central role in supporting urgent humanitarian operations in six countries in Africa and Asia.

Rewind a year and the world was on the precipice of a global food crisis - caused by structural factors but exacerbated by the war - with almost 10 per cent of the world population facing acute food insecurity.

Today, with the collapse of the deal, the world could soon face similar conditions.

Global food security must not be allowed to fall victim to the conflict in Ukraine.

This was always the position of the International Chamber of Commerce (ICC), the organisation I lead and which, back in April 2022, proposed to United Nations Secretary-General Antonio Guterres the creation of a humanitarian food corridor to allow for the export of grain and sunflower seeds from Ukraine in exchange for a relaxation of sanctions against Russian fertilisers.

At the time, food prices had soared to record levels, with food price inflation reaching as high as 1,000 per cent in countries such as Lebanon, and our view was that only resuming both Ukrainian food and Russian fertiliser trade could avert a global hunger catastrophe. A year on, the case for the deal remains as strong as ever.

Restoring the Black Sea deal must, accordingly, be an absolute priority for the international community. Failing to do so will, simply put, imperil millions of lives.

Even in the few days since the deal was scuppered, wheat futures have risen around 4 per cent. And the uncertainty around whether the agreement will be restored will only increase volatility in prices for food staples - not just wheat, but other crops as well given the impact that a potential shortage of fertilisers, such as ammonia, will have on yields all over the world.

Without a deal, the world may face yet another crisis not only of food affordability but food availability - a challenge exacerbated by liquidity constraints and increasingly unmanageable debt burdens faced by scores of countries, both developing and middle-income.

Naturally, the poorest nations will be hit hardest by the deal lapsing. The Black Sea Grain Initiative benefitted many countries by restoring wheat imports, mostly in developing countries in Asia and Africa.

But this should also be a concern for advanced economies - after all, rising food prices could lead to social, political and economic instability with the potential to rebound even to those countries able to source food from other regions.

Nigeria's recent declaration of a state of emergency due to surging food prices may be the canary in the coalmine. And policymakers would be wise to recall that a major driving factor of the Arab Spring was the doubling of food prices from 2006-08 and a serious price spike in 2010.

It is therefore imperative that all parties - not only Russia and Ukraine, but Western nations involved in the deal - continue talks on the terms under which the Black Sea agreement can be renewed. Importantly, this must involve a full recognition of the original intent of the initiative, which was to facilitate balanced agricultural trade from both Ukraine and the Russian Federation.

As superficially unpalatable as it may seem, for the West this means recognising that the agreement may require compromises on the application of trade restrictions against Russia.

For months, Russia has been arguing that it did not get its end of the bargain, insisting that it would only stay in the deal if an agreement could be reached that would allow for the fuller resumption of its own agricultural trade - including by connecting a Russian agricultural bank to the SWIFT international payments system, waiving certain sanctions on insurance that had impeded Russian shipping, and unfreezing the accounts of Russian fertiliser companies.

Adhering to these conditions - or at least reaching an agreement that would through other means fulfil the original intent of the deal to facilitate both Ukrainian and Russian agricultural trade to avert a hunger crisis - would not involve turning the West into a "bear hugger", caving into Russian belligerence or compromising efforts to support Ukraine's territorial defence.

Rather, it would be to avoid precipitating a food security crisis with truly unimaginable consequences.

Nasdaq futures are down this morning, by about 0.50% at the time of writing, after the afterhours trading session was shaken by results from two U.S. tech giants: Tesla and Netflix. For both there was good and less good news.

Tesla's price cuts that boosted sales and got the company to sell almost half a million cars less quarter, also squeezed its profit margins for the 3rd straight quarter to 9.6%. This number was almost 15% earlier this year. But Elon Musk said he believes this is the right choice still, and it certainly is. Tesla's earnings jumped 20% and total revenue rose 47% – both better than expected. But the stock price fell more than 4% in the afterhours trading. Netflix on the other hand added 5.9 mio subscribers last quarter – more than double what was estimated by analysts – as banning password sharing encouraged people to … subscribe! Note that Netflix had its 2nd best quarter since the heart of the pandemic, yet, its sales and revenue fell short of expectations due to price cuts in some markets and the unfavourable exchange rate, while Q3 forecast disappointed, and the stock fell more than 8% in the afterhours trading. Netflix rally could pause after a 175% rally since last May but Hollywood strike and the deteriorating macro conditions are not all negative for Netflix. First, Netflix gets a big chunk of its content from outside the U.S. and should help the streaming giant diversify risks from Hollywood, and second, as the living crisis in some parts of the world gets worse, people could be tempted to stay home and watch Netflix. Plus, it is said that with competition tightening its purse's strings, Netflix could find itself with less competition too. Pricewise, it could be time for a downside correction in Netflix which actually trades in overbought market conditions, but price pullbacks could also serve as interesting entry opportunities for further gains. Though, we all know that this quarter's jump in subscriptions was probably a one-off jump, making it hard to predict how the numbers be impacted in the next few quarters.

Apple also made headlines yesterday, as news that it's quietly working on generative AI called 'Ajax' but that employees call Apple GPT, pleased investors sent Apple just a few points below the $200 mark yesterday. Microsoft and Google fell more than 1% on the news. But Apple doesn't have a clear strategy for releasing the technology to customers, and no matter what they say, ChatGPT's arrival was like a bomb, and it will be hard to dethrone Microsoft with a bigger bang soon.

On the banks front, well Goldman Sachs was right warning investors that it was going to have a BAD quarter, because it really had a BAD one. I mean its earnings slumped 58% last quarter on investment banking – the worst among the big U.S. banks and the return on equity – the key measure of profitability – fell 4%. That was also the worst among the big U.S. banks. But happily, investors were prepared for the bad news and barely reacted. The bank shares will likely come under pressure in the coming weeks in expectation of tighter capital rules.

Overall, the S&P500 and Nasdaq both extended gains yesterday but we could see some consolidation and downside correction today. The U.S. 2-year yield remains steady around 4.70/4.80% range, as Federal Reserve (Fed) officials are in their quiet period before the next policy meeting and can't insist that there will be more rate hikes on horizon! The U.S. dollar index consolidates and slightly corrects near the overbought territory. The dollar-yen tested the 140 resistance, again, on the back of softening Bank of Japan (BoJ) expectations with no more than a fifth of forecasters predicting that the BoJ will adjust its YCC policy this July. The new governor Ueda is sticking to easy policy and the improved functioning of the bond market doesn't call for urgent action. October is now the month that investors expect a change to happen.

Cable tipped a toe below the 1.29 mark yesterday after the latest inflation figures came in softer than expected yesterday morning and helped traders trim a 50bp hike expectation for the next meeting. While the euro took the opposite direction, after the core CPI came in higher than expected, at 5.5% in June. The latter somehow pushed back the European Central Bank (ECB) doves that were boosted earlier this week by comments from ECB's Knot that a rate hike beyond the next policy meeting is all but guaranteed.

In commodities, wheat futures were up 8.5% yesterday as Russia fuels tensions in the Black Sea. Russian Defense ministry said that all vessels in the Back Sea heading to Ukrainian ports will be considered potential carriers of military cargo starting from today.

Whisper it, but for all the warnings of a Turkish financial market meltdown if Tayyip Erdogan won May's Presidential vote, some parts of it have done rather well, although the lira's drop has been as punishing as predicted, if not worse.

From a stock market rally to one of the worst performing currencies in the world, the charts below show how extreme the moves have been and what investors are watching out for next.

The lira has slumped 25% since Erdogan secured his victory and installed new Finance Minister Mehmet Şimşek and central bank chief Hafize Gaye Erkan who seem to have given the currency much more room to do its own thing.

It is down over 30% for 2023 as a whole, pipped only by Nigeria which slashed at the naira with a super-sized devaluation last month and perennial pariah Argentina

The pace of the lira's fall has been accelerating though, meaning it could soon overtake those two unless the tide turns. Many investors think that will only happen if interest rates go to levels just too high for investors to pass up.

The central bank will announce its second post-election rate decision at 1100 GMT. Last month it raised rates sharply to 15%. Now economists expect it will go to 20%.

"You wonder whether they have left it too late" said Mikhail Volodchenko at one of Europe's largest fund managers AXA IM. "You need a lot of things to go right," he added, to avoid some kind of drama.

The lira may have buckled but Turkey's stock market has soared and not just because of locals piling in to protect their money from a renewed rise in inflation.

Foreign investors scooped up $231 million worth of Turkish shares in the week to July 7, according to central bank data, in what was a fifth straight week of buying.

Even more impressive has been the post-election burst of outperformance by MSCI's Turkey index, which is dollar-denominated and therefore accounts for the lira's woes.

"Implementing policies to stabilize the exchange rate, easing inflation concerns and improving economic conditions may positively affect investor confidence and lead to the continuation of optimism," said Enver Erkan, chief economist at Dinamik Yatirim.

The switch back towards more orthodox-looking policies has cut the premium, or 'spread' in banker speak, investors demand to buy Turkey's dollar-denominated government bonds rather than the U.S. Treasuries to the lowest since COVID broke out.

That move has meant the bonds have now done better this year than the worldwide benchmark for emerging market debt, the JPMorgan EMBI Global Diversified index.

There have been other helps too. Erdogan last week unexpectedly gave the green light to Sweden's NATO bid after months of delays.

Just a day later the EU's powerful lending arm, the European Investment bank, which has long had a ban on lending in Turkey, approved a 400 million euros ($448 million) package to help the post-February earthquake rebuild effort.

And on Wednesday Erdogan landed $50 billion worth of deals from the United Arab Emirates on one of his first stops on a tour to wealthy Gulf Arab nations.

"No one is really overweight Turkey," said Simon Lue-Fong, a fixed income head at Swiss-based fund manager Vontobel, referring to investor positioning. "But if it looks like things are changing then it can do well."

In contrast to the dollar bonds, Turkey's 'local' lira-denominated bonds have had a shocker.

The mix of higher interest rates and the lira's collapse means they have lost a whopping 38% in dollar terms versus an 11% gain on the world's main local currency debt index, the JPMorgan GBI EM.

Even if the lira is taken out of the equation the bonds are still down around 13% since Erdogan's election win.

"It is the only local market in world where both the bonds and the currency are weaker this year," said Aegon Asset Management's head of emerging market debt Jeff Grills.

One of the big grumbles investors have is that Turkey is in a cycle where high inflation hits the currency which then raises the price of importing everything from food to fuel.

Analysts forecast headline inflation will now stay above 40% for another year and Michael Metcalfe at State Street Global Markets says prices scraped off the internet in real time already show it is going up again.

"This likely reflects a direct response to the collapse in the Lira in the past two-months," Metcalfe said, adding the data pointed to a sharp reacceleration of the monthly inflation rate to back above 4%.

($1 = 0.8920 euros)

Markets have pared back their near-term rate hike expectations over the past few days. The final element, which had a significant impact on sterling rates, was the UK CPI print yesterday morning, which also saw services inflation fall below what the Bank of England itself was projecting. At 7.2%, it is still elevated but could make the difference between another 50bp move or a smaller 25bp hike at the upcoming central bank meeting in August. It certainly made a difference for the terminal rate markets are anticipating, which further declined to just over 5.8% coming from a peak of pricing of 6.5% earlier this month.

The UK data print helped feed the general narrative that inflation dynamics are starting to look more encouraging. Even the European Central Bank could point to its very own 'supercore' inflation measure, which posted a third monthly decline in a row yesterday (albeit still painfully high at 5.7% year-on-year). The data was released along with the final eurozone inflation data for June, which saw the official YoY core reading being revised up by a tenth to 5.5%.

EUR rates also reacted to the UK data initially, but their bigger move had already occurred the day before on the back of the unusually dovish comments by one of the ECB's hawks Klaas Knot. A July hike is a "necessity", he remarked, while anything beyond July "would at most be a possibility but by no means a certainty." Bundesbank President Joachim Nagel had also sounded less determined with regards to September earlier this week, stressing that the decision would emerge from a data-dependent approach.

Market pricing for the September ECB meeting now sees a rate cut hanging in the balance, although markets are still more inclined to see the ECB hiking once more after July before the year is over, putting the probability of the ECB reaching a 4% depo at 80%. It will indeed be more questionable whether we will get as firm a commitment for the next meeting in the upcoming press conference as we did in June for July. At the same time, the ECB is also unlikely to signal the end of its tightening cycle.

Over the summer, the ECB will this time have two CPI releases (for July and August) to contemplate and will also have new forecasts available in September. Other ECB officials such as Governing Council member Gediminas Simkus also reminded us yesterday that there are still scenarios where the central bank might do more, including a revisit of quantitative tightening discussions next year. The ECB has set the bar it has to clear with regards to inflation relatively high, not wanting "to be surprised again by sudden and significant changes in the wrong direction".

Against that backdrop, it might not surprise that the EUR front end was reluctant to further trim the chances of a September hike to below 50%.

It's unusual to see eurozone rates and U.S. rates moving in opposite directions, but that is exactly what we saw yesterday. The U.S. market saw the higher-than-expected inflation print as an issue for the eurozone to price in, and by implication without consequence for the US. At the same time, the U.S. has already re-priced to reflect the relative robustness of its economy. The Fed funds strip continues to account for this, with the liquid portion of the strip out to early 2025 not dipping below 3.75%. Further out it gets down to 3.6%, but there are no volumes to speak of out there. Either way, adding a 30bp term premium to this suggests that the U.S. 10yr yield could easily be closer to 4% here.

It's far from a perfect model, but it does help to explain why the 10yr yield has not collapsed lower, and in fact, we rationalise this as a factor that can force U.S. yields higher as a tactical view. It goes against the consensus out there that the inflation story is behind us, but is rationalised by the reality that macro robustness can always reignite the inflation bubble in the months and quarters ahead. For this reason, we maintain a moderate bearish stance on the directional view, expecting market rates to remain under moderate rising pressure. The fact that risk assets remain in risk-on mode pushes in the same direction.

As we approach summer, many investors are taking chips off the table and trading is becoming more choppy surrounding the competing narratives of easing inflation and economic resilience. At the moment, the market seems to take the middle ground, attaching a growing possibility to the most benign outcome of a 'soft landing'.

As for today, the main focus is on U.S. data, with the release of the initial jobless claims as the highlight. The consensus is for very little change, which would support the notion of a resilient jobs market, but surprises here have seen some volatility in the past. Other releases are the Philadelphia Fed business outlook and existing home sales. The Conference Board's Leading index is seen extending its fall, and it has been pointing to weaker economic activity ahead already for more than a year.

European supply will come from France and Spain. The French nominal bond auctions are targeting shorter maturity bonds out to 6 years, but France will also launch a new 11-year linker. Spain will active out to the 27-year maturity. The U.S. Treasury launches a new 10Y TIPs inflation linked bond.