As the Federal Reserve ebbs closer to raising interest rates, investors are once again examining asset classes and exchange traded funds that are vulnerable to higher borrowing costs in the U.S. That group includes plenty of emerging markets ETFs and perhaps none are more vulnerable to changes in Fed policy than the iShares MSCI Turkey ETF (NYSEArca: TUR).

Global investors are dumping Turkish bonds, making the lira one of the worst-performing emerging currencies against the dollar this year. The central bank is under increased pressure to act in order to assuage market fears and prop up the quickly depreciating lira currency, especially in an uncertain political climate where there is rising risk of a snap election – President Tayyip Erdogan could call for a snap election on August 23 if a coalition government has not formed. The government has been the most vocal about cutting interest rates to stimulate growth. [Central Bank no Help to Turkey ETF]

However, recent elections in Turkey helped calm investors’ nerves though those results cannot protect Turkish financial markets from higher interest rates in the U.S. Nor do those results hide the fact that Turkey’s lira has been one of the worst-performing emerging markets currencies this year.

“With it now so obvious that the Fed will hike, we believe the Central Bank of Turkey should go ahead and normalise in November …. If it raises the policy rate by 150 basis points to 9% it will look [like]a decisive move, but practically it will leave the average cost of central bank funding unchanged (and it will allow overnight rates to fall). The net result of a rate hike of this magnitude should actually be lower benchmark rates (which are elevated closer to 10% due to the daily 10.75% overnight rate),” according to a Renaissance Capital note posted by Dimitra DeFotis of Barron’s.

Istanbul’s benchmark stock index has underperformed the MSCI Emerging Market Index amid political upheaval – Turkey’s ruling party failed to secure a majority in the June national elections, which created uncertainty in the markets as the country works on hodgepodge coalition.

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