BofA Sees More Life in World-Beating Bond Advance: Turkey Credit

BofA Sees More Life in World-Beating Bond Advance
Turkish bonds are rewarding investors who bet on a country with the world’s largest current-account deficit after the U.S., a higher inflation rate than east European peers and a currency that was the worst performer against the dollar last year. Photographer: Kerem Uzel/Bloomberg

Turkey’s first investment-grade rating in almost two decades kicked off the best month since January for bondholders, and Bank of America Merrill Lynch is among those saying there are more gains to come.

Yields on two-year notes dropped 115 basis points this month after Fitch Ratings upgraded the country on Nov. 5, the most among 19 major emerging markets tracked by Bloomberg and triple the decline for second-placed Poland. The investment-grade rating, the first since 1994, sent the cost of insuring Turkish debt using credit-default swaps to below that of higher-rated Russia, Israel and South Africa.

“Bonds remain the asset to hold in Turkey,” Arko Sen, a debt strategist at Bank of America Merrill Lynch, said by e-mail from London yesterday. “Given the ratings trajectory, foreign allocations to local bonds have room to increase.”

Turkish bonds are rewarding investors who bet on a country with the world’s largest current-account deficit after the U.S., a higher inflation rate than east European peers and a currency that was the worst performer against the dollar last year.

Yields hit a record low of 5.93 percent today, extending their decline this year to 508 basis points, or 5.08 percentage points, also the biggest drop among the 19 major emerging markets. The drop in November was beaten this year only by the 157 basis-point decrease in January, Bloomberg data show.

Still Junk

Credit-default swaps, which pay out should a borrower renege on debt agreements, fell to 130 basis points today, 15 points above a record low in 2006.

A subsequent upgrade from either Standard & Poor’s or Moody’s Investors Service would be needed for Turkish bonds to be certified as investment grade and included in some global indexes that would bring additional investment inflows.

S&P ranks Turkey two levels below investment grade after five straight increases since the aftermath of a currency crisis in 2001. Moody’s puts the country at its highest junk grade after three increases since 2005, the last in June this year.

Moody’s on Nov. 21 rejected arguments for an upgrade used by Fitch, citing risks in funding Turkey’s current-account deficit. It kept Turkey’s debt at Ba1. Moody’s said Turkey was the only country in Europe with a positive outlook. It didn’t give a schedule for its next review, saying a ratings action could occur at any time.

Dedicated Funds

“I still think it’s possible that Moody’s will upgrade Turkey sometime during the first half of 2013, which should attract more traditional non-emerging markets-dedicated investors to buy Turkey bonds,” Esther Law, a strategist at Societe Generale SA in London, said by e-mail yesterday. “I see potential for the local bond yield to go lower from here, especially as we see the usual first-quarter risk rally.”

The local-currency bond market is being boosted by central bank Governor Erdem Basci’s record-low interest rates as he tries to stimulate domestic demand.

The pace of economic growth declined to 2.9 percent in the second quarter, the slowest since a 2009 economic contraction. The increase in gross domestic product will probably accelerate to 4 percent in 2013 from 3.2 percent for 2012 as a whole, according to government estimates.

Basci lends to banks within a so-called corridor of 5.75 percent, the benchmark one-week repo rate, and an upper limit of 9 percent, the overnight lending rate. Banks can also finance themselves at competitive auctions using a one-month rate, which helped drive the average cost of funding to 5.63 percent as of Nov. 28, a record low.

Lira Rally

The lira weakened less than 0.1 percent to 1.7864 against the dollar in Istanbul today, bringing this year’s gain to 5.9 percent. That marks a turnaround from last year, when the currency dropped 18 percent against the dollar.

Investors took fright from surging loan demand that swelled the current-account deficit to $77.1 billion by the end of 2011, or about 10 percent of GDP. The deficit narrowed for an 11th month in September as imports waned, while inflation dropped to 7.8 percent last month from 10.5 percent at the end of 2011.

Bonds last year also plunged, with yields rising 390 basis points. Credit-default swaps surged to 300 basis points.

In the past month, Turkey’s swap prices have fallen 33 basis points to 130, as its creditworthiness improved. That put them below Russia at 135, Israel at 141 and South Africa at 149. Russia and South Africa are each rated three levels higher at Moody’s, and Israel is six levels higher.

Keep Going

The extra yield investors demand to hold Turkey’s dollar-denominated debt over U.S. Treasuries was unchanged at 176 today, according to JPMorgan Chase & Co.’s EMBI Global Index. That gives Turkey the second-lowest rate in major eastern European markets, behind Poland. The extra yield for Hungary’s debt was double that for Turkey at 368 basis points, and the emerging market average was 285.

“The lira will perform better and the market will get used to the easing rhetoric of the central bank, so Turkey will keep on outperforming its peers,” Bugra Bilgi, manager of the hedge fund at Turkiye Garanti Bankasi AS, Turkey’s biggest bank by stock market value, said in an e-mail from Istanbul yesterday.

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