Record-Low Lira Wrecking Investment Case for Troubled Turkey

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(Bloomberg) -- The Turkish central bank’s repeated failure to catch up with inflation has left the country’s assets at the bottom of the emerging-market pile.

Resurgent consumer prices have revived a selloff in the lira, just when the currency was defying weakness among developing-nation peers in the wake of U.S. Treasury yields hitting the 3 percent mark. The losses are spilling over to bonds and equities, ruining the carry trade, and earning the markets some unsavory superlatives.

Read: Turkish Lira Plunges to Record After Inflation Data

“It confirms the CBRT is behind the curve,” Guillaume Tresca, a Paris-based senior strategist at Credit Agricole SA, said referring to the central bank. “In a normal world, they will have to tighten monetary policy further.”

It’s anything but a normal world. Turkey is heading for a presidential election on June 24, before which policy makers have little room to take meaningful action against inflation. The economy is under siege from rising oil-import costs, the worst current-account deficit in emerging markets and foreign-currency reserves that have dwindled to less than a 10th of gross domestic product.

Vanishing Carry

Any pain in Turkey’s markets starts with the lira and this time is no exception. This week’s decline in the currency is the biggest in almost two years and takes 2018 losses to 10 percent. That means carry traders have lost 6 cents for each dollar they borrowed to invest in lira assets.

That’s ironic, because Turkish companies pay about 13.5 percent to borrow funds and making money off their hunger for capital should be a no-brainer. The yield on lira assets implied by forward contracts jumped to a nine-year high Thursday. But surging volatility is reducing the appeal.

The lira is heading for the worst week since 2008 as investors including JPMorgan Chase & Co. say the country will need further rate increases to arrest the slide.

Read: Here’s One Sign Favoring Emerging-Market Currencies Amid Selloff

Steeper Yields

Bond traders are raising their inflation expectations.

Just last week, the yield on 10-year government bonds fell to a record low relative to the rate on 2-year notes, reflecting traders’ expectations that policy makers will keep short-term rates high. But now, they’re betting that Turkey will remain hobbled by runaway inflation for a long time to come. As a result, the yield on the 10-year debt is rising faster.

Read: One Thing in Favor of Turkish Bonds: Few Foreigners Like Them

Earnings Boost, Valuation Slump

Average analyst forecasts for lira earnings by members of the Borsa Istanbul 100 Index are extending a record high.

But that’s evoking little enthusiasm from investors. The index has lost 16 percent since January, suggesting that investors aren’t too keen to pay a higher premium to own Turkish equities. In fact, the valuation has slumped to a nine-year low.

The worst hit in the equity markets are the country’s banks and financial companies. Investors pay no more than 4.4 lira for every lira of profit at Turkish banks in the next 12 months. Compare that with the sentiment on Indian banks, where multi-billion-dollar scandals are being unearthed, but investors pay 16 times earnings.

Given that both India and Turkey are net oil importers, it’s clear that the latter’s problems aren’t just about oil prices. There’s a deeper rot that investors worry about.

“The move to a more authoritarian political system and curbs on the freedom of expression will stymie long-term economic development,” said Per Hammarlund, chief emerging-markets strategist at SEB in Stockholm. “Turkey needs to do more to address the shortfall in domestic savings that is the root cause behind the wide current-account deficit.”

©2018 Bloomberg L.P.

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