International investors are ramping up exposure to Turkey, focusing on local bonds and Credit Default Swaps (CDS) as monetary policy normalization is becoming more deep rooted, investors and analysts said.
Almost a year ago, President Tayyip Erdogan - then fresh from securing an election victory - endorsed big interest rate hikes sought by markets to tackle runaway inflation, marking a shift from an unorthodox policy that had deterred investors from Turkey for nearly a decade.
The central bank has raised its policy rate by 4,150 basis points in total since June last year. In its policy meeting on Thursday, the bank kept the main interest rate steady at 50% as expected, though it remained wary of inflation risks.
“Investors are getting back in quite aggressively now - the numbers are really strong. There’s been a lot of inflows,” said Nick Eisinger, co-head of Emerging Markets Active Fixed Income at Vanguard, which has more than $7 trillion in assets under management.
“We’re long on the lira. We’re long on the local bonds, but not a lot, and then we’re quite long on the credit,” he said, referring to the country’s hard-currency debt.
Analysts at Citi agreed, saying the shift in policy had stimulated interest in Turkish assets.
“We see the current moment as somewhat of a renaissance for Turkish markets across local, external, corporate credit and equity markets,” Citi’s Luis Costa wrote in a note to clients.
The rally across Turkish assets has been broad-based, with the country’s main stock index up more than 46% since the beginning of the year, propelled by an around 80% rally in the banking sector over the same period.
Returns on domestic government bonds are more than 4% year-to-date, far outperforming the less than 1% on the wider JPMorgan GBI-EM Global Diversified index.
The bonds had already enjoyed an initial wave of foreign interest in November, after which it cooled. But interest had been revived after a 500 basis point interest rate hike in March and the opposition’s success in local elections that followed on March 31.
STABILIZING LIRA
Turkey’s hard-currency debt has returned 2.4% - broadly in line with the wider JPMorgan EMBI Global Diversified index. However, over the last 12 months, returns for Turkey were at 24.6% - more than double those of the wider index.
While the lira has weakened more than 8% against the dollar year-to-date, the currency has stabilized since hitting a record trough in mid-April.
Monetary conditions are quite tight now, said Vanguard’s Eisinger, with de-dollarization underway.
“In real terms, the currency appreciates, which is a good thing, and they want to do that because it’s a good anchor to cut inflation,” Eisinger said.
On stocks, Citi said it had turned neutral on banks following the strong share market rally. Turkish Banks Association Chairman Alparslan Cakar said the banking sector was strong, with no problems in asset quality and the non-performing loans rate low.
Looking forward, CDS - instruments used to insure exposure to an issuer against default - could be the next big trade for investors, said Eisinger.
Turkey’s 5-year CDS stood at 264 basis points on Thursday - less than half the 673 bps they were at 12 months ago.
“Turkey’s CDS could easily be 225 if they get it right - that’s a big trade,” said Eisinger. “If you put that on in size and they get that right, that’s a big deal.”
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