(Bloomberg) -- Turkey’s lira rebounded from its biggest retreat in eight years after the government thwarted a coup attempt that erupted Friday. Bonds tumbled as the cost of insuring the country’s debt soared, while shares in Turkish Airlines and banks led a slump in stocks.
The currency gained 2 percent to 2.9553 per dollar as of 12:15 p.m. in Istanbul, trimming Friday’s 4.6 percent decline, as traders said local investors were selling dollars to take advantage of Friday’s selloff. The Borsa Istanbul 100 Index, which had closed before the clashes began, dropped as much as 5.2 percent. Yields on 10-year government bonds soared 44 basis points.
The crisis has undermined a recovery in Turkey’s assets driven by a slowdown in inflation and confidence central banks around the world will keep pumping cash into the biggest economies. That means any rebound this week driven by bargain-hunting will probably be short-lived, given a resurgence of political risk, according to Piotr Matys, a strategist for emerging-market currencies at Rabobank in London.
"The damage has been done," Matys said, adding that events were "seriously challenging" an earlier forecast that the lira would stay below 3 per dollar this year. "We expect Turkish assets to be vulnerable in the short term and the lira to remain volatile in the coming days. If the rule of law and checks and balances are seriously undermined in the coming months, this could lead to capital outflows."
The Istanbul index of bank shares dropped 7 percent, its biggest decline in more than a year. Investors also fled stocks linked to Turkey’s tourism industry, already reeling from a series of terrorist bombings across the country. Airport operator TAV Havalimanlari Holding AS fell 13 percent. Turkish Airlines, also known as Turk Hava Yollari, declined 8 percent.
Bonds also fell, with the yield on Turkey’s dollar bond due February 2045 rising 18 basis points. The cost of insuring exposure to Turkish debt rose, with five-year credit default swaps widening 17 basis points to 242. It had fallen to the lowest in a year last week.
Goldman Sachs Group Inc. lowered its forecasts for the lira over the weekend, saying the currency will slide to 3.10 per dollar within three months, revising its earlier forecast of 2.95.
“While the immediate level of uncertainty has been sharply reduced post the failure of the takeover and a renewed coup appears unlikely, we expect the level of political risk will remain elevated and hence have implications for the economy,” Clemens Grafe, a Moscow-based economist at Goldman, wrote in a report.
In an effort to quell investor concern, policy makers said Sunday they will provide unlimited liquidity to banks and would support the lira by removing limits on foreign currency deposits that commercial lenders are allowed to use as collateral. While the coup attempt may have a negative impact on Turkey, especially on tourism, reforms will now be easier to carry out, Deputy Prime Minister Mehmet Simsek said in an interview with Bloomberg HT from Ankara aired on Monday.
The central bank is scheduled to hold a policy meeting Tuesday and the median estimate of economists surveyed by Bloomberg as of Friday was for a further 50-basis-point reduction in the overnight lending rate.
The Turkish central bank has lowered the overnight interest rate by 175 basis points this year amid slowing inflation, supporting a rally in Turkish assets. The yield on Turkish five-year local currency bonds has dropped more than every other emerging-market nation this year except for Indonesia and Brazil.
While the economy has been among the biggest beneficiaries of the global clamor for yield as central banks pump cash into economies, Friday’s coup attempt left some 200 dead and has been followed by massive reprisals that risk unnerving investors.
Thousands of army officers and judges were swept up in a nationwide wave of arrests as Erdogan and the ruling AK Party moved to cement power. While some investors express concern that the president’s quest to centralize power leaves the nation vulnerable to social unrest, others see his survival as the surest bet of stability for a NATO ally entangled in the war in neighboring Syria and in conflicts with Kurdish separatists.
The market could demonstrate a "sanguine take on events over the weekend, given that security has been restored,” Timothy Ash, a credit strategist at Nomura Plc in London, said in an e-mailed note. “This could offer the prospect of a more stable political environment as a result, albeit leaving longer term concerns over the course of economic policy and democracy.”