The Turkish Crisis: What You Need To Know About Erdogan, The Lira, Turkey

U.S. stocks and the Turkish lira plummeted Friday after President Donald Trump threatened to double tariffs on steel and aluminum and said diplomatic relations with Turkey are “not good.” Here’s a rundown of what investors need to know.

Where Problems Started

The lira began its steep sell-off Friday morning after a Turkish delegation was unable to make progress on negotiations to free detained U.S. pastor Andrew Brunson, who is being held in Turkey under accusations of supporting a coup.

Following the initial sell-off in the lira, Turkish President Recep Tayyip Erdogan urged Turkish citizens to step in and buy the lira.

“Change the euros, the dollars and the gold that you are keeping beneath your pillows into lira at our banks,” Erdogan said. “This is a domestic and national struggle.”

In July, Trump threatened “large sanctions” against Turkey in retaliation for Brunson’s detention. On Friday morning, Trump seemed to make good on his threat in a message posted on Twitter. Trump blasted the lira and said he has doubled steel and aluminum tariffs.

I have just authorized a doubling of Tariffs on Steel and Aluminum with respect to Turkey as their currency, the Turkish Lira, slides rapidly downward against our very strong Dollar! Aluminum will now be 20% and Steel 50%. Our relations with Turkey are not good at this time!

— Donald J. Trump (@realDonaldTrump) August 10, 2018

The lira tumbled 20 percent versus the U.S. dollar on Friday morning.

As a result of the escalating tensions, both the Turkish and U.S. stock markets took a hit Friday. The iShares MSCI Turky Invstbl Mrkt Indx Fnd TUR plummeted 19.1 percent and is now down 53.4 percent year-to-date. The SPDR S&P 500 ETF Trust SPY declined 0.6 percent but is still up 6.2 percent overall in 2018.

Potential Fallout

Unfortunately for all investors, the dispute between Turkey and the U.S. has a far-reaching global impact. The European Central Bank is reportedly concerned over the health of southern European banks, which have lent large amounts of money to Turkey. According to the Bank of International Settlement, Spanish banks hold $83.3 billion of Turkish debt, French banks hold $38.4 billion and Italian banks hold $17 billion.

Defaults on debts this large could threaten the stability of the European financial system.

Outside of the Eurozone, other banks around the world are also heavily exposed to Turkish debt. Japanese banks hold $14 billion of debt, U.K. banks hold $19.2 billion and U.S. banks hold $18 billion.

The Financial Select Sector SPDR Fund XLF traded lower by 1.4 percent on Friday, but European bank stocks such as BBVA Banco Frances S.A. (ADR) BFR, Deutsche Bank AG (USA) DB and Banco Santander, S.A. (ADR) SAN were all down more than 4 percent on the day.

Fortunately, some experts believe the potential damage is mostly contained.

“I don't see huge global contagion,” Bluebay Asset Management strategist Timothy Ash told CNBC. “Turkey is still a relatively small economy [worth] $850 billion, and [it's] unlikely this will be sovereign debt event.”

TD Ameritrade Chief Market Strategist JJ Kinahan echoed that sentiment and is more concerned with other areas of the markets. 

"Obviously they’ve had issues with their economy for a while, so it’s not a complete surprise so to speak. Where I think more people are struggling is what’s going on with the bond reaction. Bonds and crude are where people are struggling right now. Why would crude be up so much with the dollar up?"

For now, investors will be watching Trump’s Twitter feed closely for any updates on the developing situation.

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