Metamorphosis curves of Turkish financial markets after Erdogan’s re-election

LONDON, July 20 (Reuters) – Despite all warnings of a collapse in Turkey’s financial market in the event of Tayyip Erdogan’s victory in May’s presidential election, some market segments have performed well since then, although the fall in the lira was as fast as expected, if not worse.

The charts below show how extreme the swings have been – from a rally in Turkish stocks to the trouble of one of the world’s most affected currencies – and what investors should expect in the future.

1/ HOW LOW YOU CAN FALL Since Erdogan’s victory and the appointment of Mehmet Simsek as the new finance minister and Hafize Gaye Erkan as central banker, whom the country’s president appears to have given carte blanche so they can operate independently of the lira, the Turkish currency has lost 25%.

Throughout 2023, it fell by more than 30%, surpassing only the currencies of Argentina – a perennial weaker position on the forex markets – and Nigeria, which recorded a very large devaluation of the naira in June.

However, the lira’s rate of decline is accelerating, meaning it could soon come last behind its Argentine and Nigerian counterparts unless there is some sort of turning point. Many investors believe that this will only happen when interest rates in Turkey reach attractive levels for investors.

The Turkish Central Bank on Thursday raised its key interest rate by 250 basis points to 17.5% from 15.0%. Economists polled by Reuters expected an increase in credit costs to 20.0%.

“The question is whether they did it too late,” said Mikhail Volodchenko of AXA IM, adding that many factors must come together to avoid drama.

2/ LARGE SHOPPING

The lira may have sunk, but Turkey’s stock market has skyrocketed, and not just because Turks are investing in stocks to protect their funds from another spike in inflation.

According to the central bank, in the week leading up to July 7, foreign investors bought Turkish shares for USD 231 million, continuing net buying for the fifth week in a row.

Even more impressive was the post-election rise of Turkey’s MSCI index, which is denominated in dollars and thus adequately takes into account the problems of the lira.

“Policy of stabilizing the exchange rate, easing inflation concerns and improving the economic situation can have a positive impact on investor confidence and support optimism,” said Enver Erkan of Dinamik Yatirim.

3/ LOVE IS AROUND

The move to a more orthodox monetary policy has seen the premium or, in banking parlance, the spread that investors demand when choosing Turkish dollar government bonds over US Treasuries, fall to their lowest level since the beginning of the coronavirus pandemic.

As a result, Turkish bonds outperform the global benchmark for emerging market debt, the JPMorgan EMBI Global Diversified Index in 2023.

Other factors also helped. Last week, Erdogan unexpectedly gave the green light to Sweden’s application to join NATO after months of delay.

A day later, the EU’s powerful lending authority, the European Investment Bank, which had long refused financial support to Ankara, approved a €400 million ($448 million) aid package to help rebuild the country after February’s earthquake.

And on Wednesday, Erdogan struck deals worth $50 billion with the United Arab Emirates during a visit to the wealthy Gulf states.

“Nobody has an advantage over Turkish assets,” said Simon Liu-Fong of Vontobel about investor positioning. “But if you can see that the situation is changing, then Turkey can show good results.”

4/ LOCAL PROBLEMS

Unlike dollar bonds, “local” Turkish lira bonds took a huge hit.

The combination of higher interest rates and the collapse of the lira saw such bonds lose 38% in dollar terms, compared to the 11% gain of JPMorgan GBI EM, the world’s leading index of emerging market government debt in local currencies.

Even excluding the lira from the calculations, bonds have still fallen by around 13% since Erdogan’s election victory.

“It’s the only local market in the world where both bonds and currencies have weakened at the same time this year,” said Jeff Grylls of Aegon Asset Management.

5/ INFLATION PAIN

One of the biggest concerns for investors is that Turkey is in a cycle where high inflation hits the currency, pushing up the prices of imported goods, from food to fuel.

Analysts expect core inflation to stay above 40% for another year, with Michael Metcalfe of State Street Global Markets believing that prices based on real-time web data have already resumed their upward trend.

“This is probably a direct reaction to the collapse of the lira in the last two months,” Metcalfe said, adding that the data showed another spike in inflation to above 4% on a monthly basis.

($1 = €0.8920)

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(Mark Jones and Kanan Sevgili, translated by Tomasz Kanik. Editor Anna Kozlova)