Investors Scramble for Liras as Turkish Swap Rates Touch 1,000%
Investors dumped Turkish bonds and stocks on Wednesday after the nation orchestrated a currency crunch to prevent the lira from sliding days before an election that will test support for President Recep Tayyip Erdogan’s rule.
The cost of borrowing liras overnight on the offshore swap market soared past 1,000 percent at one point on Wednesday because local banks are under pressure not to provide liquidity to foreign fund managers who want to bet against the lira. A government official said the measures are temporary.
This has forced investors who want out of their lira positions to instead sell other Turkish assets to get the cash they need to close those trades. The yield on two-year Turkish bonds jumped above 20 percent and stocks slid the most since July. Fund managers including Japan’s Daiwa SB Investments Ltd. said they are rethinking investments in the country.
“I’ve never seen a move like this in the 21 years I’ve been watching this market,” said Julian Rimmer, a trader at Investec Bank Plc in London. “This amounts to sacrificing long-term pragmatism for a short-term political expedient. Such tactics will make many traders question the investability of the lira.”
By engineering a situation whereby investors can’t move out of liras easily, Turkish authorities have averted a currency slide before a March 31 vote that’ll determine who governs Turkey’s cities. That’s good for Erdogan, who’s already contending with a recession, soaring inflation and opposition parties trying to undermine him. But it comes at the cost inflicting pain on the investors Turkey needs to roll over $177 billion of foreign-currency debt coming due within the next 12 months.
Turkey’s main stock index fell 5.7 percent on Wednesday, almost erasing all of its 2019 gains. The yield on two-year bonds climbed 47 basis points to 20.45 percent and the cost of insuring Turkish debt against default jumped.
Even the lira, which rallied on Monday and Tuesday, couldn’t escape the rout, as local companies and individuals loaded up on dollars, according to two traders who declined to be identified. As a sign of how bearish Turks are on their currency’s prospects, households and businesses are now holding more of their savings than ever before in dollars and euros. The currency weakened 1.4 percent to 5.4035 per dollar as of 8:37 a.m. in Singapore on Thursday after closing little changed the day before.
Turkish officials confirmed on Wednesday that foreigners were struggling to get out of lira positions. One senior official said the measures are backed by the government and aren’t permanent. Policy makers remain committed to a freely floating currency, although regulators will act to prevent any excessive depreciation even after the elections, said the official, who declined to be named because civil servants aren’t allowed to speak to the media.
The turmoil for foreign investors started late last week when — after months of relative calm — the lira slid 5.1 percent in a single day on Friday. The selling came on the heels of a research note from JPMorgan Chase & Co. recommending investors get out of the lira.
That marked a U-turn because the lira had become a darling for currency traders since the central bank raised interest rates to 24 percent last September. But with elections only a week away, the bearish call provoked a stern reaction from Turkish authorities, who accused the New York-based lender of giving "misleading" and "manipulative" advice. Erdogan even warned on Sunday that bankers deemed responsible for speculating against the currency would be punished.
The threats increased the resolve of foreign hedge funds to close their lira positions, only to find the Turkish banks they usually do business with weren’t willing to provide cash for the trade. Even before the latest developments, Turkey imposed a limit last summer on how much banks could lend to overseas counterparties of 25 percent of equity, a move designed to help prevent speculative attacks on the lira.
As an indication of how bad the liquidity crunch is, the cost of borrowing the lira overnight in the offshore market surged more than 40-fold over the last three days to the highest since Turkey’s 2001 financial crisis. That’s why the lira’s gains this week aren’t offering an relief to investors with long positions; the high foreign-exchange funding rates are likely to wipe out any money they might have made in closing those trades.
Why Most Lira Longs Aren’t Cheering the Rally
Erdogan, who was sworn in with vast executive powers last June, has been campaigning across the country for the ruling AK Party, which is facing competitive municipal races in the capital of Ankara and the commercial hub of Istanbul this weekend. That poses a threat to its quarter-century-long hold on the two cities.
“The important thing to watch is policy after elections,” said Shamaila Khan, the New York-based director of emerging-market debt at AllianceBernstein Holding LP. “The government tends to veer towards more orthodox policy when under pressure”
One of the reasons investors suddenly soured on the lira last week was data that revealed the central bank had drawn down billions of dollars in foreign-exchange reserves in March, prompting speculation it was using them to prop up the lira before the elections to avoid the kind of volatility that happened last year.
Some analysts and investors contacted by Bloomberg, who declined to go on the record for fear of backlash from Turkish authorities, said that as the lira becomes a very difficult currency to trade, investors may be less inclined to invest in Turkey in the future.
Takeshi Yokouchi, an emerging-market fund manager at Daiwa SB, was forced to backtrack on a plan to add to his Turkish bond investments because of the constraints in trading. Instead, he’s going to rotate some of his lira holdings into longer-duration bonds or cash.
“With the swap moves, I’m now forced to take an unusual strategy,” he said.
©2019 Bloomberg L.P.