Real Yields at Two-Year High Offer Little Comfort: Turkey Credit

Turkish bond yields near the highest in two years once inflation is accounted for are proving insufficient to lure traders seeing the need for further rate increases to shore up the weakening currency.

Real yields on Turkey’s two-year notes touched 3.66 percent on Jan. 28, the most since October 2011, according to data compiled by Bloomberg. That’s higher than Russia, India, Indonesia and South Africa, the data show. Turkish producer prices surged 10.7 percent in January from a year earlier, a report showed yesterday, suggesting the full effect of lira weakness has yet to be passed onto consumers, who saw inflation accelerate more than forecast in the period, to 7.5 percent.

The prospect of above-inflation returns isn’t enough to compensate investors for the risk of further lira declines after the currency slumped 17 percent in the past 6 months. Economy Minister Nihat Zeybekci said on Feb. 1 that the central bank’s doubling of interest rates last month was “temporary,” threatening to undermine the central bank’s efforts to bring price growth toward its 5 percent goal.

“Real yields look OK today, but we might see consumer inflation edging toward 9 percent by April,” Mehmet Besimoglu, an economist at Oyak Menkul in Istanbul, said by e-mail yesterday. “It might be early to talk about investors getting confident. The major risk is currency volatility.”

Lira Plunge

Turkish two-year real yields have risen from last year’s low of minus 2.07 percent reached on April 29. Bond yields climbed as the lira lost 22 percent against the dollar in the past 12 months amid political turmoil and a reduction in U.S. monetary stimulus that roiled emerging markets.

A graft probe targeting the government became public on Dec. 17, leading to the resignation of three ministers and the arrest of the chief executive of a state-run bank. The Federal Reserve lowered its monthly bond-purchase program by $10 billion to $65 billion at its last meeting Jan. 29, the second consecutive reduction.

The lira’s plunge to consecutive records in January was arrested by a doubling of interest rates by the central bank after an emergency meeting Jan. 28. Still, rates will need to rise further, according to Goldman Sachs Group Inc. and Morgan Stanley.

Turkey’s two-year real yield compares with 7 percent in Brazil, 2.6 percent in South Africa, 0.28 percent in Russia, minus 0.59 percent in Indonesia, and minus 1.3 percent in India.

Inflation Expectations

The lira gained 0.6 percent to 2.2704 per dollar at 9:50 a.m. in Istanbul, taking its advance to 3 percent since Jan. 24, the day before the central bank announced its extraordinary meeting. It reached an all-time low 2.3900 on Jan. 27.

Outright yields on two-year notes, which fell as low as 4.79 percent on May 17, five days before former Fed Chairman Ben S. Bernanke said he was considering ending U.S. monetary stimulus, fell one basis point yesterday to 11.04 percent.

Central Bank Governor Erdem Basci revised his 2014 inflation forecast on Jan. 28, to 6.6 percent from 5.3 percent. Bond investors expect consumer-price growth to average 7.7 percent in the coming two years, according to so-called break-even rates, the difference between yields on inflation-linked and regular bonds.

‘Impossible’ Inflation

“Reaching 6.6 percent appears almost impossible in this environment,” Ozgur Altug, chief economist at BGC Partners in Istanbul, said by e-mail yesterday. “Out of 23 sub-sectors of manufacturing we did not even see a single one cutting its prices in January. This suggests that in the coming period CPI inflation might rise further.”

Goldman Sachs said yesterday it sees the rate at 8.3 percent by year-end.

A 10.9 percent increase in food prices drove inflation last month. The so-called core-price index, which excludes volatile items including energy, food, beverages, tobacco and gold, accelerated to 7.6 percent from 7.1 percent in December.

“It still pays to wait for a couple more data points to see whether food prices make a downward correction,” Yarkin Cebeci, an Istanbul-based economist at JPMorgan Chase & Co., said in an e-mailed report yesterday. “If this is not the case, the inflation forecast will need to be revised towards the 8 percent mark.”

Before it's here, it's on the Bloomberg Terminal.