Turkish Bond Market Returns to Normal as Inflation Accelerates

  • 10-year yield climbed above 2-year for first time in 10 months
  • Investors demand higher return as price growth accelerates

Turkey’s yield curve is showing signs of returning to normal.

The nation’s 10-year bonds were this week yielding more than two-year notes for the first time in 10 months as investors demand higher returns to compensate for accelerating inflation and the country’s deteriorating risk profile.

Turkey’s short-term notes have yielded more than longer-dated bonds since February as the central bank kept liquidity tight and overnight lending rates high. This inversion is now ending after inflation quickened to the highest in more than a year and as investors shunned riskier assets amid rising tensions in the Middle East.

At the same time the yield on two-year bonds is effectively capped as the market now sees little chance of an interest-rate increase, according to Erkin Isik, a strategist at Turk Ekonomi Bankasi in Istanbul.

The central bank’s “recent communication showed that they are very unlikely to hike rates and are even looking for an opportunity to cut the upper band of the interest rate corridor, if conditions permit,” Isik said. “The long-end is more sensitive to inflation and the credit outlook, so with the dovish central bank and bad inflation outlook, the bond curve steepened.”

Lira Drop

Some investors remain worried the central bank will have to raise interest rates to support the lira. The currency weakened for a fourth day to 3.0066 per dollar at 5:11 p.m. in Istanbul, around two percentage points away from a record low.

“Price action in the lira will eventually raise fears of an unexpected rate hike," said Kerem Baykal, a fund manager at Ak Portfoy in Istanbul. "As a result, I think that the bond curve’s next move will be toward inversion. That’s why I like the long-end better than the short-end at these yield levels."

The yield on Turkey’s 10-year bonds has jumped 46 basis points this week to 11.20 percent. The spread over two-year bond yields widened to as much 49 basis points in early trading on Wednesday. The yield on 10-year bonds later fell to two basis points below the two-year at the close.

In April, two-year bonds yielded as much as 103 basis points more than 10-year debt.

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