Turkish Lira Slide Marks Return of Erdogan Political Risk

President Recep Tayyip Erdogan is reviving a political battle that helped drive the Turkish lira to a record low in January, and again yesterday.

The currency weakened to an all-time low and two-year note yields rose the most in emerging markets after Russia yesterday, as police detained at least 20 people at media groups linked to a U.S.-based cleric accused by Erdogan of plotting against the government. Declines across emerging markets were sparked by speculation the U.S. is moving toward raising interest rates.

“Political risk draws attention to Turkey’s domestic and external weaknesses -- particularly at a time when sentiment towards risk assets is deteriorating markedly,” Nicholas Spiro, managing director of Spiro Sovereign Strategy in London, said by e-mail yesterday. “What’s patently clear is that the lira remains one of the most vulnerable emerging market currencies.”

Erdogan said yesterday in a speech in Kocaeli, western Turkey, that the police operations were cutting espionage contacts. He said the arrests aren’t “a matter of press freedom,” defying condemnation from the European Union and saying it should “mind its own business.” The former prime minister has repeatedly vowed to go after supporters of the cleric Fethullah Gulen, blaming them for a corruption probe into his government that was made public a year ago tomorrow.

Past Best

The lira weakened today to 2.4146 per dollar, a record low, and traded at 2.37 at 3:40 p.m in Istanbul. The previous record was 2.39 per dollar in January, when the central bank responded with an emergency meeting to raise its benchmark interest rate by 550 basis points. Russia followed a similar course today, boosting its main interest rate by 650 basis points at a surprise post-midnight meeting to try and stop losses in the ruble.

The yield on Turkey’s two-year notes jumped 23 basis points to 8.51 percent yesterday, and another 45 basis points today to 8.96 percent. The cost to protect government bonds using five-year credit default swaps rose 40 basis points in two days to 231, for a 44 percent increase this month.

Turkish assets have been among the top performers in emerging markets this year, as the 44 percent collapse in oil prices helped reduce its current-account deficit. This month, the bonds and currency are among the five biggest decliners as Europe’s economic slowdown and the potential for rate increases from the Federal Reserve weigh on investor appetite. Oil fell 3 percent today to $59.25 a barrel, down from an average of more than $108 per barrel last year.

‘Too Long’

“Markets went too long lira-denominated assets and they are now looking to release some of this risk,” Luis Costa, a currency strategist at Citigroup Inc. in London, said by e-mail yesterday. “The markets have recently read new legs down in oil prices as risk-off events, and the lira can’t rally in a market like that.”

Fed policy makers gather this week to review their stance on the timeframe for an interest-rate increase. Turkey’s central bank meets to decide borrowing costs on Dec. 24.

Turkish markets may bounce back once the Fed provides clarity on its course of action this week, according to Turker Hamzaoglu, an economist at Bank of America Corp. in London.

“The global backdrop is still the dominant driver here and it remains supportive of Turkish assets,” he said. “We shouldn’t try to read too much from the market moves.”

No Surprise

The arrests on Dec. 14 didn’t come as a surprise, according to Benoit Anne, a London-based strategist for Societe Generale SA.

“Investors since the episode last year have rediscovered the need to price in higher political risks in Turkey,” he said.

Erdogan’s government responded to the corruption charges implicating four ministers by firing or replacing thousands of police officers involved in the probe, which he characterized as a coup attempt. Among those arrested last weekend was Ekrem Dumanli, editor-in-chief of Zaman, a newspaper distributing around a million copies a day. Dumanli is accused of leading, forming and being a member of an armed terrorist organization.

The renewed domestic turmoil gives investors less motive to buy Turkish assets, according to Isik Okte, a strategist at TEB Investment, a brokerage in Istanbul. That leaves it exposed to repeated bouts of volatility.

“Just because the Brent crude price is falling, you can’t expect to buy the lira and think you are immune from the Fed,” Okte said by e-mail yesterday. “With the emerging-market carnage in the last two days, what do you sell? Lira.”

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