Turkey Gloom Seen in Yields Above Russia as Inflation Risks Grow

  • Real yields on lira bonds climb to highest since 2011
  • Bond allure tempered by political risk, inflation outlook

In a sign of just how pessimistic investors are growing on Turkey, real yields soaring above Russia still aren’t high enough for many bondholders.

The slump in Turkish government bonds has sent two-year yields rising nearly 3 percentage points this year, lifting the extra rate over inflation to more than 4 percent, the highest since 2011. Real yields on equivalent debt from South Africa and Russia, countries with similar credit ratings, are at least 190 basis points lower.

Bondholders’ wariness reflects security risks in Turkey and a worsening political environment after failed coalition talks triggered early elections.
It also reveals investors are convinced inflation has bottomed as the third-biggest depreciation among major currencies this year lifts prices for imported goods while the expected increase in U.S. interest rates threatens further lira declines.

“The attractiveness of the currently elevated real Turkish bond yields on offer is tempered by a high political risk premium, prospects of increasing domestic inflationary readings from exchange rate pass-through, and high volatility from movements in rates and currency markets,” Phoenix Kalen, an emerging market strategist at Societe Generale SA in London, said by e-mail.

The yield on South Africa’s two-year government debt adjusted for inflation was 2.3 percent while the yield on equivalent Russian bonds was negative 4.8 percent.

Police Raid

As the country gears up for general elections in November following the inconclusive June vote, tensions are rising. The latest political flash-point -- a police raid on the headquarters of Koza Ipek Holding, a conglomerate linked to the U.S.-based cleric Fethullah Gulen, a onetime ally turned enemy of President Recep Tayyip Erdogan.

The lira weakened 0.6 percent to 2.9483 per dollar at 1:29 p.m. in Istanbul, extended its decline to 21 percent this year, threatening to unwind the slowdown in inflation. Consumer prices will edge up in August for the first time in three months to 6.9 percent, according to the median estimate in a Bloomberg survey ahead of the data from statistics office in Ankara on Thursday. The slide in oil prices helped lower inflation from as high as 9.5 percent last year.

Even economists who predict a further decline in inflation tomorrow say this is now the trough. “A re-acceleration driven by foreign-exchange weakness seems likely,” Ahmet Akarli at Goldman Sachs, who predicts a slowdown to 6.6 percent, said in an e-mailed report last week. Morgan Stanley raised its year-end inflation target to 8 percent from 7.6 percent in an Aug. 31 report.

Juicy Yield

“Inflation is one uncertainty for sure as we have yet to see the price increases in imported goods following the most recent leg of the lira’s depreciation,” Cagdas Dogan, a banking analyst at BGC Partners in Istanbul, said by e-mail. “And of course it is unclear how much of a real yield investors would require out of Turkey going forward, given the political uncertainties that we are facing.”

The rising real yields are luring some investors.

Yields “look very nice and juicy now,” Dmitri Barinov, a fund manager at Union Investment Privatfonds GmbH in Frankfurt, who has a “moderately overweight” holding in Turkish local bonds, said by e-mail Tuesday. “They are pricing quite a lot of risk and are attractive here, but it is a matter of taste.”

Risks include potential interest-rate increases by Turkey’s central bank in response to the U.S. Federal Reserve, according to Ibrahim Aksoy, a strategist at HSBC Asset Management in Istanbul. Turkey’s central bank has kept rates unchanged since February despite the lira’s weakness.

“The possibility of a sharp rate hike due to potential lira weakness on political uncertainty and global factors like the Fed and the global slowdown is the real risk for the bond market,” Aksoy said. “It is difficult to expect sustained declines in bond yields.”

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