Rate Cut a Matter of When Rather Than If on Rally: Turkey Credit

The biggest drop in Turkish bond yields in more than three weeks is signaling investors see the central bank gearing up for interest-rate cuts, with economists debating when, not whether, they will occur.

Governor Erdem Basci sparked the rally two days ago when he said that he may cut borrowing costs should the recent decline in the country’s risk premium stick and the inflation outlook improves. The yield on Turkey’s two-year lira notes dropped the most since April 8 that day, falling 42 basis points to 9.12 percent, making the securities the best performers in April among 21 emerging-market bonds tracked by Bloomberg.

“The fact that yields dropped to their current levels mean everybody believes that a rate cut will materialize soon,” Ercan Erguzel, an economist at Denizbank AS in Istanbul, said by e-mail on April 30.

The central bank has been under pressure from Prime Minister Recep Tayyip Erdogan and his government to cut rates after unexpectedly raising them in January to halt a slide in the lira. Some economists say it’s too early to do that, with inflation still above Basci’s target and the currency’s recent rally vulnerable to capital outflows. For politicians in a presidential-election year, the priority is growth, which is forecast to slow.

Not Important

Erdogan urged Basci on April 4 to cut rates immediately. Economy Minister Nihat Zeybekci said April 30 that “inflation isn’t that important” and the bank should cut rates to spur investment and growth. He also said the central bank should intervene to weaken the lira if it gains past 2.10 per dollar.

Since March 25, the lira has rallied about 6 percent against the dollar, making it the best-performing emerging-market currency. It strengthened 0.3 percent to 2.10 per dollar at 5:04 p.m. in Istanbul.

Basci, who has repeatedly said that the central bank’s independence is not under threat, said this week that a “normalization” of monetary policy would reflect a decline in Turkey’s sovereign risk premium, and shouldn’t fuel inflation, which the bank expects to slow to 7.6 percent this year from 8.4 percent in March. The target is 5 percent.

He said a rate cut wouldn’t necessarily be the start of a series, and didn’t give a time-frame.

The governor pointed to the drop in the cost of insuring Turkish dollar-denominated debt against default using a five-year credit-default swap. It fell to 192 basis points today from 266 on March 24, according to data compiled by Bloomberg.

Capital Inflows

That reflects recent capital flows into Turkey, which may enable Basci to make his move as early as the next monetary-policy meeting on May 22, according to Inanc Sozer, chief economist at Odeabank AS in Istanbul.

“We see that the investor appetite toward emerging markets has recently increased,” Sozer said. He said the bank may cut its one-week repo rate, which was raised to 10 percent in January, by 50 basis points this month if the improvement in risk premiums persists.

Other economists don’t expect the bank to act that quickly. JPMorgan Chase & Co. expects a rate cut in September. “We doubt that the markets will provide the central bank the necessary room to deliver” earlier, though the risk is on that side, economist Yarkin Cebeci said in an April 30 report.

The central bank on April 24 kept the benchmark repo rate at 10 percent and the overnight lending and borrowing rates, which mark the boundaries of his so-called interest-rate corridor, at 12 percent and 8 percent.

Goldman Prediction

Finansbank AS economist Gokce Celik predicted that the earliest the central bank could move is July, assuming that June inflation figures mark the start of a slowdown.

Goldman Sachs Group Inc. is an outlier. After Basci’s April 30 speech, its economists Ahmet Akarli and Kasper Lund-Jensen maintained their view that his next move will be a rate increase, triggered by lira weakness, though they added that “today’s dovish comments increase the risks to this view.”

Ilker Domac, an economist at Citigroup in Istanbul, said cutting rates now “would be premature and reverse the salutary impact of the January rate hike in stabilizing the lira and bolstering investor sentiment.”

Fitch Ratings echoed the warning. Succumbing to government pressure to lower rates too quickly puts the bank at risk of pushing the economy into a “boom and bust” cycle, Paul Rawkins, a senior director at Fitch, said on April 30.

Basci said this week that policy will only be eased when investors are convinced that inflation will come down.

“The central bank said there would be no further rate increases and that it will cut if inflation is favorable,” Bugra Bilgi, a hedge-fund manager at Garanti Asset Management in Istanbul, said by e-mail. “And the market bought this.”

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