Turkey’s risk is edging closer to Russia’s for bondholders as President Recep Tayyip Erdogan lobbies for increased presidential power and the economy deteriorates.
This year’s plunge in Turkish assets has lifted yields on 2023 dollar bonds to within 65 basis points of equivalent Russian debt, from a 365 basis-point discount at January end.
As Russia’s risk eases with a recovery in oil prices and cease-fire in Ukraine, investors are funding bond purchases by selling assets in Turkey, an oil importer. They are betting the the trade may have further to run as Turkish inflation accelerates, pre-election polls signal an unclear outcome on June 7 and the ruling AK Party plans to push for rewriting the constitution.
“Russia’s outperformance has still some way to go,” said Michael Ganske, who has bought Russian bonds and sold Turkish securities since January for the $6 billion of emerging-market assets he helps oversee at Rogge Global Partners Plc in London. “With oil up and increasing, the fundamental rationale to go out of Turkey and into Russia is valid,” he wrote in an e-mail May 8.
It’s not just the potential extension of Erdogan’s power that’s spooking bondholders. If the ruling AK party fails to get enough votes to govern without a coalition, he may be unable to push through policy changes to revive an economy hemmed in by higher crude prices and a 13 percent currency plunge this year.
“As long as oil prices keep rising and the direction of economic policy in Turkey is suspect, investors will continue to rotate out of Turkey and into Russia,” said Alexander Moseley, a senior money manager and sovereign specialist for emerging-market debt at Schroders Plc in New York.
A gauge of Russian dollar bonds tracked by Bloomberg has returned 14 percent this year, compared with 0.1 percent from Turkish securities. Turkish local bonds lost 2.1 percent versus a 21 percent gain in Russia.
With elections four weeks away, the window of opportunity to benefit from this trade may be closing, according to Alistair Ling, a money manager at GLG Partners LP in London.
“No one wants to be long going into the election,” Ling said by e-mail. “But valuation wise, it’s starting to get interesting and if it continues to underperform, starting to add pre-election might make sense.”
For now, investors continue to sell as Brent crude’s 39 percent rebound from a six-year closing low in January undermines the appeal of Turkish assets. Unemployment in the country is at a five-year high. Gross domestic product will expand 3.4 percent in 2015, according to a Bloomberg survey of economists, compared with 7 percent in the AK Party’s first five years in power.
The central bank has raised its inflation forecast to 6.8 percent from 5.5 percent, further away from its target of 5 percent. Standard & Poor’s downgraded the nation’s local-currency credit rating last week, and said political intervention is making central bank Governor Erdem Basci’s job of curbing inflation harder.
The cost to protect bondholders against default by Turkey in the next five years has been surging this year, edging closer to comparable credit default swaps for Russia. The gap has narrowed to 114 basis points from as wide as 438 basis points at the end of January, according to data compiled by Bloomberg.
Ogeday Topcular, who helps oversee $250 million in emerging-market debt at Ram Capital SA in Geneva, said he reallocated between 5 and 10 percent of his portfolio away from Turkey and into Russian dollar debt since January.
“Russia has done much better than our expectations,” Topcular said. “It’s a bit of a reversal trade from what we did last year when the conflict in eastern Ukraine started.”