Turkey crisis' contagion to Mexico and Brazil seems all too likely

Outlook:

The inflation data on Friday came in exactly in line with expectations, with headline CPI at 2.9% and core CPI at 2.4%, the most since September 2008 but still no match for the Fed’s preferred measure at 1.9%. All the same, the data reinforces the universal belief that the Fed is on track to hike again in September. Why this would be dollar-positive at this point is somewhat mysterious. We could just as easily have seen the dollar drop on the inflation announcement as a “sell on the news” event. Instead the Fed-affirming inflation story reinforced the flight-to-quality story. 

Cause and effect in FX can be hard to untangle and sometimes the only way to get a guess is to imagine the effect of X if Y were in the opposite condition. If the Fed were not on rate-hiking program, would the Turkish crisis be spreading? If the US were not squabbling with Turkey—as NATO ally, let’s not forget—would the Turkish crisis be less dire? The squabble was a trigger, to be sure, but plenty of other triggers can be imagined. In other words, some situations are so dire that crisis is inevitable. Which of many possible triggers actually does the job doesn’t really matter all that much.

Turkey is not over by a long shot. Contagion to the other prime targets like Mexico and Brazil seems all too likely. The deduction is an ever-rising dollar (and ever falling yield) until Something Else comes along to shake things up. Even if European banks manage to hide or correct their exposure, the euro is a victim of contagion, too.

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