By Wayne Cole and Lawrence White
SYDNEY/LONDON (Reuters) – The fallout from Turkey's latest market drama appeared contained on Monday, as stocks recovered from President Tayyip Erdogan's shock replacing of a hawkish central bank governor with a critic of high interest rates.
An index of Europe's 600 largest stocks hovered either side of flat by 1058 GMT, erasing earlier losses. Euro zone government bond yields fell slightly and other emerging- market currencies largely avoided contagion.
Erdogan's move most affected domestic assets. The lira fell 15% to 8.485 against the dollar, its worst plunge since the last Turkish crisis of 2018, before the currency recovered on calming words from Finance Minister Lutfi Elvan.
By 1058 GMT, the currency traded at 7.950 after Elvan said Turkey would stick to free-market rules, damping down fears of currency controls.
Turkish sovereign bond yields soared above 18%, hitting a 22-month high.
Meanwhile, euro zone banks exposed to the country such as Spain's BBVA, Italy's UniCredit, France's BNP Paribas, and Dutch bank ING fell between 1.6% and 5.2%.
The MSCI emerging-market currency index was down about 0.1%, with such high-yielding currencies as the South African rand and the Mexican peso down about 0.8% and 1.4%, respectively.
The ripples were more modest elsewhere. U.S. stock futures were up while yields on 10-year Treasury notes edged down five basis points to 1.68%, suggesting some investors favoured safe havens.
Investors are still struggling to deal with the recent surge in U.S. bond yields, which has left equity valuations for some sectors, particularly tech, looking stretched.
Bonds had another wobble on Friday when the Federal Reserve decided not to extend a capital concession for banks, which could lessen their demand for Treasuries.
The damage was limited, however, by the Fed's promise to work on the rules to prevent strains in the financial system.
A host of Fed officials speak this week, including three appearances by Chair Jerome Powell, providing plenty of opportunity for more volatility in markets.
WATCHING EMERGING MARKETS
Monday's tumble in the lira saw the yen strengthen, with notable gains on the euro and Australian dollar.
After an initial slip, the dollar steadied at 108.80 yen. The dollar index was down slightly at 91.942.
Also supporting the yen were concern that Japanese retail investors who have built long lira positions, a popular trade for the yield-hungry sector, might be squeezed out and trigger another round of lira selling.
Still, analysts at Citi doubted that the episode would lead to widespread pressure on emerging markets, noting the last time the lira slid in 2020, there was little spillover.
"In terms of impact on other parts of the high-yielding EM, we believe that will be quite limited," Citi said in a note.
There was scant sign of safe-haven demand for gold, which eased 0.65% to $1,734 an ounce .
Oil prices teetered on renewed concerns that European coronavirus lockdowns could slow any recovery in demand for fuel products. [O/R]
Brent crude was down 13 cents, or 0.2%, at $64.4 a barrel by 1103 GMT>. U.S. oil recovered some earlier losses to rise 24 cents to $61.28, after both contracts had fallen by more than 6% last week.
(Reporting by Wayne Cole and Lawrence White; editing by Lincoln Feast, Christian Schmollinger, Kirsten Donovan, Larry King)