Financial markets are signaling that more pain is to come in Turkey’s financial markets, as long-time leader President Recep Tayyip Erdogan seeks to secure the re-election that narrowly eluded him almost two weeks ago.
Bets have risen for an eventual decline in the nation’s tightly managed currency as money managers prepare for Erdogan to face rival Kemal Kilicdaroglu in Sunday’s presidential run-off. Stocks and overseas bonds have also slumped.
The 69-year old incumbent fell short of victory in the election’s first round on May 14, winning 49.5% of the votes. Now traders are weighing the possibility of changes to his unconventional economic model, built on interest-rate cuts to boost growth even as inflation surged, alongside tight control of the exchange rate. Turkey’s government has been intervening heavily to support the lira, causing Turkey’s net reserves to drop below zero for the first time in 21 years.
“There is a limited runway for these measures to prop up the lira and Turkish credit without an orthodox policy shift,” said Patrick Curran, a senior economist at London-based Tellimer. “Without sharp rate hikes and lira devaluation to attract foreign investment and rein in the current-account deficit,” he said, “the house of cards will eventually come crumbling down.”
To Kaan Nazli, a money manager at Neuberger Berman in The Hague, Turkey likely has “some, but not much, room to continue interventions” as reserves dwindle. Including swaps lines with lenders and other central banks, he estimates the country could access between $23 billion and $25 billion more in spendable cash.
That isn’t much compared to the $177 billion that authorities spent in foreign-exchange markets to back the lira over 16 months, according to an estimate by Bloomberg Economics.
The currency, at just shy of 20 against the US dollar, is lingering near a record low, with derivatives traders pricing in a 52% chance that it slides to 29 per greenback in the fourth quarter.
That compares to a 36% probability of such a depreciation that traders saw when the results of Turkey’s first round of voting showed they were wrong to wager on a quick end to the unconventional policy mix.
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Market’s Shift
Turkey’s assets are signaling a shift in investor sentiment since the lead-up to the first round. At the time, some traders were positioning for changes that would set the nation’s $900 billion economy on a more sustainable growth path.
The Borsa Istanbul 100 Index rose about 9% in the week leading up to the vote. In the two weeks since, the gauge is down by almost the same amount. Turkey’s lenders have taken the brunt of that loss, with bank stocks down 23% since the first round and fully erasing an early May advance.
There’s evidence that bets in foreign-bond markets are being recalibrated, too.
The extra yield investors demand to hold Turkey’s sovereign dollar bonds over comparable US Treasuries has soared by as much as 1.85 percentage points in the past two weeks, according to data from JPMorgan Chase & Co.
That risk premium reached 6.33 percentage points earlier this week, the most since September — and well above the emerging-market average of 4.75 percentage points.
Amid the spike in yields, Turkey’s central bank asked some local lenders to step in and buy the bonds this week — a move that provided a slight boost to the securities.
Even so, the UK’s largest asset manager, Legal & General Investment Management Ltd., has turned neutral on Turkish debt after covering an underweight position following the first vote.
“The expectation is that Erdogan will win, so I think that is priced in the market,” Uday Patnaik, the firm’s London-based head of emerging-market fixed income, said. “The question is whether there is any change to his unorthodox monetary policy.”
For Patnaik, it’s best not to add exposure to the country until an answer is clear. While there’s a scenario in which a victorious Erdogan throws “a carrot to the market,” hinting at a shift in recent policy, challenges would remain, he said.
Other investors have taken an even more cautious approach, helping push up the cost to protect holders of Turkish bonds against the threat of default over the next five years. Credit-default swaps for the nation’s foreign debt surged to above 700 basis points this week, from less than 500 basis points before the first vote.
“Even local investors are very wary of buying Turkish eurobonds at present – if they’re even able to secure the dollars needed to buy,” said Cagri Kutman, a Turkish market specialist at London-based KNG Securities LLP. “That’s driven by the risk of a further selloff in the coming days.”
What Bloomberg Economics Says...
“Whoever wins on May 28 will have a chance to herald credibility-building changes. These could involve appointing market-friendly faces to key economic posts, a reversal of the central bank’s accommodative stance and undoing its complex web of alternative tools and stealth interventions.”
— Selva Bahar Baziki, economist. Click here to read more.
--With assistance from Tugce Ozsoy and Selcuk Gokoluk.