By Marc Jones
LONDON (Reuters) – Two years of hard work to build international investor confidence in Turkey’s economic turnaround story has been dealt a major setback by a long-feared detention of President Tayyip Erdogan’s main political rival.
Turkey’s bonds and stock market have become a big draw for global money managers recently, as the painfully high 40%-50% interest rates it employed to tackle its inflation demons have lured investors back after a series of currency crises.
Turkish assets have enjoyed some world-beating gains plus a crawling currency peg that had proved pretty reliable until Wednesday’s dramatic dive after Erdogan moved against Ekrem Imamoglu, the popular mayor of Istanbul.
The currency’s lurch was the worst since the peak of its last crises in mid-2023 and provided a crunching reminder of just how quickly Turkey’s markets can turn.
Imamoglu’s detention followed an aggressive months-long crackdown on other opposition figures, blasted by critics as a politicised attempt to silence dissent.
The main opposition Republican People’s Party (CHP) had looked poised to name the two-term mayor as its official presidential challenger in coming days. There has been talk Erdogan might opt for an early election in the next year or two, looking to extend his third decade in power after a series of geopolitical wins boosted his polling numbers.
Kaan Nazli, an emerging market portfolio manager with Neuberger Berman, described the latest events as “a serious blow to the investor confidence in the economic stabilization programme”.
Investors had hoped politics would take a back seat until 2028, with the next Presidential election scheduled to be held no later than May that year. Nazli also pointed to the risk of Turks being spooked into converting their lira savings into dollars or euros again as in previous crises.
Finance Minister Mehmet Simsek, architect of Turkey’s turnaround efforts since his appointment in 2023, said authorities were doing everything necessary to ensure healthy functioning of markets.
He did not elaborate, but bankers estimated the central bank had sold a minimum of $5 billion in FX reserves to try and stabilise the lira and that it might be as much as $10 billion for the day.
“No one needs a market reaction like this to their policy change,” Kieran Curtis at Aberdeen said, referring to the move against Imamoglu. “A lot of people (investors) have to cut risk today.”
International funds have been gradually rebuilding their lira bond exposures since Simsek brought economic orthodoxy back. Turkey has now become one of the most crowded trades in world markets, traders say.
Over the last 12 months its local currency bonds have made 18.5%, the second best in the world behind South Africa and quadruple the 4.7% global emerging market index average.
Turkish stocks, meanwhile, have outperformed MSCI’s main EM benchmark by more than 100 percentage points since the last big lira crash in 2023.
Despite Wednesday’s whiplash, analysts at JPMorgan said Turkey bonds were still one of the local currency markets they were recommending in the current environment of global trade war worries.
However, the process of reining in inflation is likely now to happen at a slower pace JPM said and it now sees interest rate cuts to reduce in size to 150 basis points at a time rather than the 250 basis points it has been chopping by recently.
“We expect authorities to prioritize market stability in the coming days,” JPMorgan’s analysts said. “Reserve buffers are likely to be utilized heavily, but should be sufficient to manage carry outflows, in our view.”
STEAMROLLERED
Wednesday’s debt market hit was big though, with a 170 basis point sell-off in the local currency bond curve.
“It’s a natural ‘sell-EM’ type of view, because you had one assumption yesterday, and that assumption is being challenged,” State Street’s Timothy Graf said, referring to Turkey’s politics.
Francesc Balcells, FIM Partner’s Chief Investment Officer of EM debt, said Imamoglu’s detention hadn’t been a complete surprise given Erdogan’s past attacks on him.
But investors who have been drawn back into the country now needed to see aggressive action from the central bank to properly stabilise the lira.
Its crawling peg, which has seen the currency dribbling down around 1.5% a month on average, has underpinned the popular “carry trade” – where investment firms and hedge funds buy the government’s local bonds that give them 40% interest rates.
“The thing about carry trades is that you need low volatility. When volatility spikes the economics of the trade are no longer there,” Balcells said.
“It is one of those things where you are picking up pennies in front of a steamroller. But today that steamroller has passed through big time.”
(Additional Reporting by Karin Strohecker in London and Canan Sevgili in Gdansk; Editing by David Gregorio)
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