Two important events took place on Tuesday, the first was good news for Europe and took place in Turkey while the second was potentially catastrophic news for the world and took place in New York. Turkey's bank regulatory agency, the BDDK, has told banks operating in Turkey to reclassify delinquent loans that meet certain criteria as non-performing loans (NPLs) by 2020. In a statement Tuesday, the government body warned that this would push up Turkey's NPL ratio from 4.6% to 6.3%. This would put Turkey's NPL rates higher, yet still far better than many EU countries including Italy.
Despite the ups and downs in Turkish financial markets over the last year, the strength of Turkish banks continues to be strong. While some of their balance sheets will take a hit for the year, this will open up steps to recapitalize where necessary and offer a more transparent window on to their operations. Total loans impacted by this move will be $8.1 billion. This is a good move by the agency and will ultimately move NPLs completely off banks' balance sheets. This hesitance to ultimately write off bad loans is what caused the Japanese banking crisis, the ramifications of which still stymie Japan's economy to this day, and currently plagues Italy.
The more interesting event occurred Tuesday as the United States experienced its first major financial emergency since the end of the Great Recession. Repo (overnight lending) markets locked up and interest rates spiked. The New York Federal Reserve (Fed) was forced to step in and offer institutions $75 billion in 0% interest loans. Apparently not enough liquidity for these markets, the NY Fed came back Wednesday and offered another emergency bailout for banks again lending them billions in free cash overnight. What happened and what does it mean for broader markets into the future?
Fed Chairman Jay Powell will speak Wednesday (after this story goes to press) and declare that the Fed has cut the Federal Funds Rate target by a quarter percentage point. He will go on to speak about global events that will impact the U.S. and global economy. He may either address the liquidity crisis in repo markets head-on or may be asked to address them during the press conference but will have to address them.
Powell will say the events were idiosyncratic. That the events that took place were a perfect storm of tax bills coming due and banks investing heavily in Treasury bonds. While this may be true, banks did not plan for their liquidity needs, ultimately. Why has the Fed had to step in to rescue them now for three nights in a row? For those that remember, this is how the 2008 Great Recession kicked off and even rumors of a repeat, in the same way, is worrisome to investors as it should be.
Powell will also discuss ongoing trade tensions and the viewpoints of the Federal Open Market Committee members on raising interest rates. Markets have priced in another quarter-point cut in December meaning that the Fed will not have raised or lowered interest rates at all for the year 2018 and 2019 on net.
Powell's comments will provide direction for markets in the near term as continued opaqueness surrounding the trade war has left market participants desperately searching for direction.