Terror Alarm Turns Turkey From Best to Worst in Emerging Markets

Attacks close to the Syrian border have turned Turkey from the best to the worst-performing emerging market.

The lira and two-year bonds tumbled the most among 24 developing markets this week as a suicide bomb, the deaths of two policemen and clashes between Turkish soldiers and Islamic State militants fueled security concerns. Before Monday’s blast, the currency was the biggest gainer in emerging economies as two-year yields fell 55 basis points since Turkey’s June 7 election.

The turn in sentiment reflects the risk of Turkey getting sucked into neighboring Syria’s four-year civil war while it’s seeking to form a government after the inconclusive elections. After losing more than 3 percent this week to 2.735 per dollar, the lira will reach 2.8, which would be a closing-day record, according to London Capital Group’s Ipek Ozkardeskaya.

“The reemergence of geopolitical tension has diminished risk appetite for lira assets,” Ozkardeskaya, an analyst who predicted the currency’s depreciation from 2.1 in mid-2014, said by e-mail from London. “Hot money won’t stay.”

Prime Minister Ahmet Davutoglu said Islamic State, which controls vast swathes of Syria and Iraq, is the principal suspect for Monday’s blast that killed 32, the deadliest in Turkey for two years. HPG, a Kurdish military organization, said it killed the police officers for cooperating with Islamic State.

Clashes across the Syrian border on Thursday left one soldier and at least one militant dead, Turkey’s state-run Anadolu Agency reported. The clashes were ongoing in Turkey’s Kilis province as of 5 p.m. Turkish time, Anadolu reported. Two more Turkish soldiers were also wounded in the shootout, it said.

Escalating Tension

Two-year yields, which jumped 31 basis points this week to 9.95 percent at 6:57 p.m. Thursday in Istanbul, may rise to 10 percent unless the unrest in Turkey’s southeast subsides, Ozkardeskaya said. Russian two-year yields rose seven basis points to 10.7 percent this week. The lira fell for the third day in four to 2.734 per dollar, the weakest since mid-June.

“The prospect of further escalation in geopolitical tensions will be another factor supporting the upside trend in the dollar against the lira,” Piotr Matys, a London-based foreign-exchange strategist at Rabobank, said by e-mail Wednesday.

The lira closed at an all-time low of 2.75 per dollar in June after the ruling AK Party lost its parliamentary majority after 13 years in power.

Amid the lack of clarity over which parties will form the next government, setting economic policy, central bank Governor Erdem Basci kept Turkey’s three main interest rates unchanged on Thursday.

Coalition Talks

The lira and bond prices had been recovering as the ruling AKP said it would try its best to form a coalition government as recently as last week.

The jihadist attack in the Turkish town of Suruc is a sign that the government’s foreign policy toward Syria is flawed and needs changing, Haluk Koc, the deputy head of the main opposition Republican People’s Party or CHP, said Tuesday. CHP is AKP’s most likely coalition partner, according to Prime Minister Davutoglu.

“The bombing adds another layer of stress to an environment already tense from the coalition talks,” Ozkardeskaya said. “Given the political rhetoric, we can expect all the gains we had seen in the lira to be reversed within the coming weeks.”

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