Turkey’s latest political turmoil has heightened risks for the lira and local bonds at a time when demand for riskier assets is already fading, analysts say.
The prospect of early elections has risen after Prime Minister Ahmet Davutoglu stepped down following a power struggle with President Recep Tayyip Erdogan, who may attempt to win a super majority needed to alter the constitution, they say. Next steps in monetary policy will also be more difficult to predict now as backing for new central bank governor Murat Cetinkaya, who was elected with Davutoglu’s support, may weaken.
After outperforming most other emerging-market currencies since the start of the year, the Turkish lira slid more than 4 percent last week as Davutoglu’s resignation sparked renewed political uncertainty. The lira is now trading near 2.928 per dollar, compared with 2.80 at the start of last week.
Analysts at Commerzbank AG including Peter Kinsella have cut lira forecasts, saying the prime minister’s departure paves the way for early elections and a move to a presidential system of governance. The bank now sees the Turkish currency weakening to 3.00 per dollar by mid-year, compared with an earlier estimate for 2.90, and to 3.25 by year-end versus 3.00 expected earlier. The analysts also lowered their economic-growth projections for Turkey to 3.5 percent for 2016 and 2.5 percent for 2017, from about 4 percent previously for both years.
Commerzbank was previously bullish about investment prospects in the country after the AK Party won a clear majority in November. That outlook has now been reversed, and the bank’s analysts see lira-denominated assets attracting a higher risk premium. They also expect elections to be held by August at the latest, keeping political risk will elevated and leading to tight liquidity and higher volatility. Political developments will curtail investment spending and it won’t be surprising to see lower growth this year and next, according to the analysts.
Morgan Stanley’s Meena Bassily says that another election cycle and risks related to monetary policy and security remain the main headwinds for the lira. The bank remains bearish on the currency, and sees it declining to 3.20 a dollar by the end of 2016. It’s maintaining its current recommendation for a short position in the lira against the South African rand, targeting a drop to 4.85 from 5.11 now.
Bearish on Bonds
Bassily is bearish on Turkish bonds and favors selling the nation’s 2023 debt, while recommending leverage investors to pay the two-year dollar-lira swap. The likelihood of Turkey’s central bank cutting its upper interest-rate bound by another 50 basis points at its May 24 meeting has decreased materially, according to him.
Rising odds of early elections or a referendum, and worsening relations with the West at a time Turkey is negotiating the recent refugee deal with European Union are among the three main risks arising from the nation’s latest developments, the bank says. A change in the current economy management will be another, it adds.
UniCredit SpA’s Kiran Kowshik says Turkey’s latest political developments reinforce a bearish view on the lira against other emerging- market currencies such as the ruble, the rand and the Indian rupee. Davutoglu’s resignation weakens support for the central bank and that means the chances of monetary-policy mistake have increased.
Societe Generale SA has closed its recommendation to buy the lira against the rand amid increased political risk, analyst Roxana Hulea says. She sees the uncertainty blurring the relative balance of risks and the future trajectory of the currency pair.
Hulea also expects the recent developments to reflect badly on the lira’s volatility going forward, not least via more scrutiny over monetary-policy independence. The bank’s year-end forecast for the lira versus the dollar is unchanged at 3.10.
HSBC Holdings Plc remains positive on the lira on a relative basis. Analyst Dominic Bunning prefers to buy it against the rand and the ruble, saying economic fundamentals are improving faster in Turkey than in South Africa and Russia. The risk is higher after the latest political developments, which represent a challenge for the lira and may trigger volatility in the short term, according to the bank.
Rabobank Groep’s Piotr Matys says Davutoglu’s exit is testing a constructive view on the lira adopted at the end of last year. He is bearish on the Turkish currency for the short term, as political uncertainty has resurfaced at a time when the fragile demand for risky assets has already faded.
The lira is also vulnerable against the dollar as a U.S. interest-rate increase in June can’t be ruled out, according to Matys. That said, it is reasonable to expect a period of consolidation in the lira following its tumble last week, before sliding back toward the record low of 3.0752 set last year, he adds.
Maya Senussi at Roubini Global Economics says Turkish politics is re-emerging as a source of risk, and is bearish on the lira. Increase in political uncertainty, including the risk of early elections, coupled with the central bank’s excessively dovish stance amid sticky inflation will result in lower capital inflows, according to Senussi. The impact could be particularly strong on the lira if carry trades decline or if risk sentiment shifts, according to Roubini Global.
London Capital Group’s Ipek Ozkardeskaya says that despite the lira’s consolidation, political risks aren’t ready to ease anytime soon. The country is stepping into a renewed period of political turmoil and upward corrections in the Turkish currency are expected to remain capped, making it an “interesting sell-the-top”, according to her.