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ECB Puts the Icing on Can’t-Miss Turkey Trade for Deutsche Bank

ECB Puts the Icing on Can’t-Miss Turkey Trade for Deutsche Bank

(Bloomberg) -- Anyone doubting the extent to which monetary policy doves in the U.S. and Europe are buttressing the world’s markets should look no further than Turkey.

The nation’s freshly appointed central bank governor bowed to calls for lower interest rates from President Recep Tayyip Erdogan and delivered a record 425-basis-point cut on Thursday, just minutes before the head of the European Central Bank set out the case for a new wave of stimulus.

Instead of unleashing a sell-off, however, traders were witness to an explosive rally in Turkey’s local bond and swap markets after the rate reduction. The lira, meanwhile, bucked a rout in emerging markets this week, and was poised for its third daily advance against the dollar on Friday.

“It’s the trade to be in over the next few weeks,” said Christian Wietoska, a London-based strategist at Deutsche Bank AG. The lira remained “surprisingly stable” after the central bank cut borrowing costs, which is “extremely positive” for the rates market, he said.

Even after its key rate was chopped down, Turkey’s lira remains one of the highest-yielding currencies in emerging markets. In a world hooked on central bank stimulus and plagued by $13 trillion of negative-yielding debt, that amounts to a license to loosen without risking an immediate reckoning with a weaker currency.

As investors piled on bets for further rate cuts, the yield on Turkey’s two-year notes broke below 17% on Friday for the first time since May 2018. Meanwhile, the Turkish lira cross-currency swap curve continued to steepen, taking the spread between one- and five-year tenors to just over 100 basis points, extending a rally from a peak of almost 1,000 points seen in March.

ECB Puts the Icing on Can’t-Miss Turkey Trade for Deutsche Bank

“On the currency front, I was expecting some underperformance, but it was short-lived,” because the lira was supported by bond inflows, said Esther Law, an investment manager for emerging-market debt at Amundi Asset Management in London. Turkey’s rate cut is “positive for short-dated Turkish bonds while the long end part of the government curve will be more sensitive to future inflation data,” she said.

That’s not to say that Turkish assets are out of the woods. After Turkey’s rate decision, the European Central Bank signaled the need for significant stimulus as the growth outlook deteriorates, denting risk sentiment.

The currency was 1.1% stronger at 5.6314 per dollar as of 4:30 p.m. in Istanbul after unwinding some of its advance following the central bank’s meeting. Gains even picked up after Erdogan said the rate cut was “not enough” and urged the central bank to proceed with gradual monetary easing.

“What happened after” the rate cut, Erdogan asked Friday during a speech in Ankara. “Did Turkey go bankrupt? Everything collapsed? Markets responded normally.”

Yield Hunt

Further cuts in Turkey are possible “under a scenario of sharp monetary policy easing by major global central banks and an ever-intensified hunt for yield,” said Marek Drimal, a strategist at Societe Generale in London. “On the other hand, a deterioration of sentiment toward the emerging-market complex or Turkey specifically might prevent the central bank from cutting further altogether.”

Last year, the Turkish central bank jacked up borrowing costs to 24%, backstopping the lira, which tumbled to record low against the dollar. The subsequent economic slowdown and ongoing geopolitical tensions with the U.S., however, kept investors at bay.

The latest central bank data shows foreign investors’ share in the local-currency bond market remained near a record low of around 13%. For some, that’s one more sign that the market is now due for a rebound, even as the central bank loosens policy.

“Our view is that the lira should continue to outperform during the summer,” Deutsche Bank’s Wietoska said. “Importantly, real rates are likely to remain positive throughout the remainder of 2019. Our sense is that foreign positioning in Turkish assets remains very light.”

To contact the reporters on this story: Constantine Courcoulas in Istanbul at ccourcoulas1@bloomberg.net;Selcuk Gokoluk in London at sgokoluk@bloomberg.net

To contact the editors responsible for this story: Onur Ant at oant@bloomberg.net, ;Dana El Baltaji at delbaltaji@bloomberg.net, Alex Nicholson, Paul Abelsky

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