Lira Bond Rally Back on Track on Output Slowdown: Turkey Credit

Turkey's Central Bank Governor Erdem Basci
Erdem Basci, governor of Turkey's central bank, said that higher lending costs introduced in December would reduce import demand and steer the economy to a “soft landing.” Photographer: Goh Seng Chong/Bloomberg

The biggest bond rally in emerging markets resumed after a worse-than-forecast slump in Turkish industrial output eased concern about the pace of the economic expansion and inflation.

Production fell 3.1 percent in January from a month earlier, slowing the annual growth rate to 1.5 percent, compared with a median forecast of 3.7 percent from nine economists surveyed by Bloomberg. Yields on two-year lira-denominated bonds retreated 23 basis points to 9.15 percent yesterday. They rose three basis points today. In the year to date they’re down 183 basis points, the most among 15 major emerging markets tracked by Bloomberg.

Turkish bonds are recovering after concern that higher oil prices would add to the world’s second-biggest current-account deficit and stoke inflation caused a four-day losing streak in lira bonds this week, the longest in more than three months. Central bank Governor Erdem Basci said in Jan. 31 in Istanbul that higher lending costs introduced in December would reduce import demand and steer the economy to a “soft landing.”

While oil prices remain the biggest concern, “news that at least on the domestic side there’s no pressure helps balance things,” said Ugur N. Kucuk, a fixed-income strategist at Is Invest, Turkey’s biggest broker. Reduced pressure on inflation also means “easing rates start to become a potential policy option,” he said in a phone interview yesterday.

Yields Plunge

The extra yield that investors demand to hold Turkey’s dollar-denominated bonds rather than U.S. Treasuries narrowed 12 basis points to 309 yesterday, while the average for developing-nation debt shrank by 11 to 344, according to JPMorgan Chase & Co.’s EMBI Global index.

The cost to insure Turkish bonds against non-payment using credit-default swaps dropped 10 basis points yesterday to 222, the lowest since August, according to data from CMA, which is owned by CME Group Inc. and compiles quotes by dealers in the privately-negotiated market. The spread is 181 for Russia, rated three levels higher by Standard & Poor’s, 185 for Poland and 161 for South Africa. The contracts would pay the buyer face value in exchange for the underlying securities or cash.

The lira declined 0.5 percent to 1.78 per dollar today after gaining yesterday, bringing this year’s rally to 5.9 percent. Traders are becoming more bullish on the currency, cutting the cost to exchange lira payments for dollars by the most in five weeks, sending the two-year cross currency swap rate falling 14 basis points to 7.27 percent yesterday. The rate was little changed today.

Revising Forecasts

“People are going to have to revise their inflation and economic growth forecasts down,” Cevdet Akcay, chief economist for Yapi & Kredi Bankasi AS, the Istanbul-based lender part-owned by UniCredit SpA, said by telephone on March 5. “Year-end inflation is going to be quite low but the average for the year quite high. As a bond investor if you can pick your maturities well that can bring quite a nice return.”

Investor concern about inflation and the current account worsened last year when Turkey’s economy expanded at the fastest pace after China among the Group of 20 major nations, spurring demand for imports that widened the 12-month cumulative current-account to a record $78.6 billion in October, equivalent to about 10 percent of gross domestic product. The lira tumbled 18 percent against the dollar in 2011, the biggest depreciation globally.

Higher Rates

Basci responded by more than doubling the rate the central bank charges for funds to lenders in late December and early January. Inflation slowed in February to 10.4 percent from a three-year high of 10.6 percent a month earlier.

While inflation was still more than double the bank’s year-end goal of 5 percent, Basci lowered the upper limit of his so-called interest rate corridor to 11.5 percent from 12.5 percent on Feb. 21. An economic slowdown is already taking place and gross domestic product growth will fall this year to the government’s target of about 4 percent, Basci said in Davos, Switzerland, on Jan. 27. GDP probably grew about 8.5 percent last year, Economy Minister Zafer Caglayan said Feb. 28.

Sales of new cars slumped 30 percent annually in February, the Automotive Distributors’ Association said March 6, extending a 29 percent decline the previous month.

Industrial capacity usage fell in February for a fourth consecutive month to 72.9 percent, the lowest in two years, according to data from the statistics institute on Feb. 23.

The HSBC purchasing managers’ index, which provides a guide to expectations for future business conditions among executives, dropped in February to 49. That was the first time the figure dipped below 50 percent, an indication of an economic contraction, since August last year, according to figures from Markit Economics published on March 1.

Falling output is “positive for bonds, at least because it reduces expectations that the bank will bring in additional tightening,” said Erkin Isik, a fixed income strategist for Turk Ekonomi Bankasi in Istanbul, said by e-mail yesterday. The January figures “aren’t enough to push the bank to adjust policy lower but if subsequent data show similar weakness, we might see that happening,” he said.

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