No Apology Needed as Contraction Boosts Bonds: Turkey Credit

Turkish Central Bank Governor Erdem Basci
Erdem Basci, governor of Turkey's central bank. Photographer: Goh Seng Chong/Bloomberg

Corrected data showing Turkey’s economy contracted the first time since 2009 is adding to profits for bondholders as yields tumble on bets the central bank will cut interest rates.

Benchmark two-year bonds rallied for an eighth day, sending lira yields down 11 basis points to 8.06 percent, the lowest since September, according to data compiled by Bloomberg. Two-year interest-rate swaps fell eight basis points to 8.93 percent, the lowest since October.

The fastest-growing major economy after China and Argentina last year shrank 0.4 percent in the first quarter from the previous three months, the statistics institute in Ankara said on July 3, apologizing for mistakenly saying the economy had expanded. Lira bonds are adding to the second best gains worldwide this year on bets central bank Governor Erdem Basci will respond by cutting rates as inflation slows.

“The economy has been on a deceleration path,” Nilufer Sezgin, chief economist at Ekspres Invest brokerage in Istanbul, said in an e-mailed report on July 3. “The contraction in the first quarter is a bit sharper than a soft landing would suggest.”

The first-quarter contraction erased a 0.4 percent expansion in the previous quarter, according to data compiled by Bloomberg. The retreat in the January-to-March period was the first since the first three months of 2009 that capped four quarterly declines in the first recession since 2001.

The latest data “does raise the chances of more rate cuts ahead,” Simon Quijano-Evans, the head of emerging market research for Europe, the Middle East and Africa at ING Groep NV in London, said in e-mailed comments yesterday.

Debt Crisis

The slowdown in Turkey’s $772 billion economy comes as consumption growth stagnates and Europe’s debt crisis cuts demand for exports by the country’s biggest trading partner and threatens the global recovery. The European Central Bank will probably lower its benchmark rate to a record low today, according to economists in a Bloomberg survey. The International Monetary Fund said the U.S. Federal Reserve may need to further ease monetary policy after cutting its growth estimate for the world’s biggest economy on July 3.

Policy makers worldwide stand ready to support economies, helping avert a hard landing for Turkey, according to Mert Yildiz, an emerging-market economist at Renaissance Capital Ltd. in Moscow.

“Any kind of landing in this global environment will be soft,” he said. “This is guaranteed since credit is still abundant, interest rates are low and demand in the west is softening, not crashing.”

Monetary Easing

The European Central Bank and People’s Bank of China cut benchmark borrowing costs, while the Bank of England raised the size of its asset-purchase program two months after halting it to stimulate demand. Stocks retreated globally as optimism with U.S. jobless claims data fizzled after Draghi said economic risks remain. Applications for jobless benefits decreased by 14,000 in the week ended June 30 to 374,000, the fewest since mid May, the U.S. Labor Department figures showed today.

The extra yield investors demand to hold Turkey’s dollar-denominated bonds rather than U.S. Treasuries rose one basis point to 295, or 2.95 percentage point, today, while the average spread for developing-nation debt increased one basis point to 366, according to JPMorgan Chase & Co.’s EMBI Global index.

Bond Insurance

The cost to insure Turkish bonds against non-payment using credit-default swaps rose three basis points to 232, according to data compiled by Bloomberg. Turkey is rated BB, the second-highest non-investment grade status, at Standard & Poor’s. Default swaps for Russia, rated three levels higher, cost 212, with contracts for Poland at 211 and South Africa at 155. The contracts would pay the buyer face value in exchange for the underlying securities or cash.

Basci introduced a so-called interest-rate corridor in October, varying rates daily to support the currency, control inflation and curb a record current-account deficit. Borrowing costs for banks climbed to 11.9 percent in January from 5.75 percent three months earlier, according to data compiled by Bloomberg.

Policy makers lowered the rate to an average 9.2 percent in June as inflation slowed more than forecast to 8.3 percent in April from a 3 ½-year high of 11.1 percent and the current-account gap shrank for six straight months. Basci currently provides funding between 5.75 percent and 11.5 percent, after lowering the upper rate 100 basis points on Feb. 21.

Lira Weakens

“The central bank will first ease by comforting the liquidity conditions and it is already doing this,” Burcu Unuvar, a senior economist at Is Invest, Turkey’s biggest broker by trading volume, said in an interview in Istanbul yesterday. The bank may loosen policy by cutting its upper band of the rate corridor, she said.

The lira weakened 0.3 percent to 1.8124 per dollar at 5:13 p.m. in Istanbul, paring this year’s rally to 4.3 percent. The currency tumbled 18 percent in 2011, the worst performance among currencies worldwide.

Data in coming months should confirm that inflation is coming down before the central bank eases rates to avoid a sell-off in the lira, Daniel Lenz, chief strategist for emerging markets at DZ Bank AG, said in e-mailed comments from Frankfurt.

“If the central bank cuts too early, we would most likely see the lira heading south again,” he said.

Economic Expansion

While price growth rebounded to 8.9 percent in June, it accelerated less than the 9.5 percent estimated by nine economists in a Bloomberg survey. The central bank forecast inflation will slow to 6.5 percent by year-end as the economy cools. Bondholders predict annual inflation will fall to 4.7 percent over the next two years, based on the so-called breakeven rate, or the extra yield on fixed-rate lira bonds over those tied to inflation.

Turkey’s economy will probably expand 4 percent this year, down from 8.5 percent in 2011, according to government estimates last year. Further signs of a deteriorating economy will probably spur monetary easing, according to RenCap’s Yildiz.

This week’s data is a possible “game-changer,” Yildiz said in e-mailed comments yesterday. “If we see another bad growth number in the second quarter -- and the bank wouldn’t wait until the official release but will track other indicators including industrial production -- then it calls for easing earlier.”

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