June 12 (Bloomberg) -- The best bond rally in major emerging markets is faltering as Turkey comes under pressure from a breakaway al-Qaeda group battling government forces in neighboring Iraq.
The lira fell yesterday by the most in more than four months, while bond yields and credit-default swaps climbed, as violence surged across parts of northern Iraq near the border. Militants from the Islamic State in Iraq and the Levant, which broke ranks with al-Qaeda during fighting in Syria, took Turkish diplomats from the consulate in Mosul captive yesterday after the city was captured two days ago.
“Events in Iraq could somehow drag Turkey in,” Timothy Ash, chief economist for emerging markets at Standard Bank Group Ltd. in London, said by e-mail yesterday. “Unrest in northern Iraq is a potential threat to the recent boon for Turkish business in the region.”
The prospect of civil war in two weakened states bordering the NATO member risks stemming a market rally that accelerated after Prime Minister Recep Tayyip Erdogan fended off corruption claims and led his party to victory in local elections on March 30. It also threatens improvement in the trade deficit as Turkish companies exported $12 billion of goods to Iraq last year, making it the biggest external market for the nation’s products after Germany.
The yield on Turkish 10-year bonds jumped 21 basis points to 9.12 percent yesterday, before falling eight basis points today. The yield declined 146 basis points since the election, the most among developing markets monitored by Bloomberg. Two-year note rates fell 20 basis points to 8.25 percent, after surging 24 basis points yesterday.
Shares in Enka Insaat ve Sanayi AS, a contractor with four construction projects in Iraq’s Dohuk, Sulaymaniyah and Erbil regions, fell 1.4 percent in Istanbul trading, extending a three-day slump to 8.1 percent. Istanbul-based Anadolu Group, the owner of Coca-Cola distributor Coca-Cola Icecek AS, said it was withdrawing workers from Mosul yesterday.
The currency gained 0.2 percent to 2.1122 per dollar at 8:30 p.m. in Istanbul as the central bank reported the current-account deficit narrowed to $4.79 billion in April. Credit-default swaps, a measure of investor risk perception, climbed nine basis points to 179 yesterday, sending them above Russia for the first time since March.
In its initial offensive on Mosul, ISIL, as the al-Qaeda offshoot is known, took more than 30 Turkish truck drivers hostage, according to Hurriyet newspaper yesterday. The country has been shipping a greater proportion of goods to the Middle East across its 330 kilometer (205 mile) border with Iraq amid disputes with Egypt following the overthrow last July of Mohamed Mursi, an Erdogan ally.
“The chaos and turmoil there is heading toward a dimension that would hurt us economically,” Arda Tunca, who traded Iraqi oil before becoming the chief financial officer at Eko Faktoring AS in Istanbul, said by phone yesterday. “Turkish companies have billions of dollars invested there -- they fully carry the Iraq risk.”
While the turmoil roiled local debt markets, it’s unlikely to deter holders of Turkey’s foreign-currency bonds, according to Sergey Dergachev, who helps oversee about $10 billion in emerging-market debt at Union Investment Privatfonds GmbH in Frankfurt. Investors will be more concerned about any effect on Erdogan’s possible bid for the presidency in August, he said.
“Investors are aware that political risk in Iraq can always blow up, so there’s no surprise effect,” Dergachev said by e-mail yesterday. “What can affect Turkish credit is the political situation, but the Iraqi situation remains so far an isolated local event.”
The yield on Turkey’s longest-dated dollar bonds, maturing in 2045, climbed three basis points to 5.57 percent.
There were conflicting reports yesterday of who controls Baiji, a town north of Baghdad and home to Iraq’s largest refinery. While police said they were providing heavy security around the town, Jabbar Yawer, a spokesman for ethnic Kurdish armed forces in Erbil, said yesterday that militants had seized the district, including refineries.
Tupras Turkiye Petrol Rafinerileri AS, Turkey’s sole refiner, said yesterday that it was seeking alternative sources of oil after the fighting. The company imported 6.1 million tons of crude in 2013 from Iraq, its top supplier.
Iraqi President Nouri al-Maliki said yesterday that government forces would seek to regain control of Mosul. A member of the Shiite sect of Islam that shares religious ties with Iran, Maliki has struggled to gain control over Sunni-majority regions.
At the headquarters of the North Atlantic Treaty Organization in Brussels, Turkey briefed its allies on developments in Mosul. It didn’t ask for assistance and has no immediate plans to do so, a Turkish Foreign Ministry official said by phone yesterday, speaking on condition of anonymity.
“Ankara is certain to face serious challenges moving forward in the region,” Aaron Stein, an associate fellow at the Royal United Services Institute in London, said in a blog post on June 10. “With little influence with the weakened central governments, Ankara now faces a reality of marginal influence and increased security threats.”
(An earlier version of this story was corrected to say the lira fell the most in more than four months instead of the most in more than five months.)
To contact the editors responsible for this story: Gavin Serkin at email@example.com Stephen Kirkland