Turkey Rout Ends After Traders Get Over Fear of Hung Parliament

  • Bonds have best rally in emerging markets in October
  • Turkey votes in elections Nov. 1 for second time since June

If bonds are any guide, the worst of Turkey’s market turmoil is over.

The country’s two-year notes have performed better than any others in emerging markets since the start of this month, while the cost of insuring against a debt default has fallen the most after Russia. The rally coincided with renewed demand for riskier assets on bets the U.S. Federal Reserve will keep interest rates near zero in 2015.

The rebound may signal growing optimism that the country’s bickering political parties will scrape together a coalition should the Nov. 1 election fail to produce a clear winner, as opinion polls predict. Since the inclusive vote in June this year, the lira weakened to a record, bond yields soared to the highest in six years and five-year credit default swaps jumped 50 percent.

“There’s definitely a feeling that the worst expectations have been realized,” Selim Yazici, chief executive officer at Teb Portfoy Yonetimi AS in Istanbul, said by phone. “The rational expectation is that a government will be formed, one way or another, regardless of the result.”

While the elections come at a time when terrorist attacks are on the rise and the conflicts in neighboring Syria and Iraq are exacerbating a domestic refugee crisis, traders are reassured that the $800 billion economy probably won’t suffer months of political limbo.

Market Rally

The yield on the government’s two-year debt plunged 142 basis points this month to 10.13 percent at 5:01 p.m. in Istanbul. The cost of protecting against default on Turkish debt fell 77 basis points from the highest in almost three years last month to 251 basis points.

Another sign that demand for Turkish securities is growing is the so-called carry return on the lira. Earnings on the trade, in which investors borrow money in currencies with low interest rates to earn returns on higher yielding assets, was 5.6 percent in October, the fourth-highest among more than 20 emerging-market currencies tracked by Bloomberg.

The AK Party, which President Recep Tayyip Erdogan co-founded, is said to weigh a possible coalition with the country’s biggest opposition party, the CHP, should next month’s election lead to another hung parliament, according to two AK Party officials. The pro-Kurdish HDP party is open to discussing a coalition with the two groups, Cumhuriyet newspaper reported.

While the market is “definitely discounting a best-case scenario,” Turkey remains a highly divided country both politically and socially, Cristian Maggio, the London-based head of emerging-markets research at Toronto Dominion Bank, said in an e-mailed note. “Reconciling the views of opposite factions won’t be easy, no matter who wins the election.”

Clashes between autonomy-seeking Kurdish militants and security forces have killed hundreds in Turkey’s Kurdish-dominated southeast, and at least 102 people died this month in Ankara in the country’s deadliest terrorist attack in recent history.

Pragmatism Prevails

The most recent polls show voter intentions are little changed from the last election in June when the AK Party lost its parliamentary majority for the first time since 2002. In theory, the nation could be forced back to the ballot box for the third time in a year if the results are inconclusive, though investors say the possibility is remote.

“We assume that pragmatism will prevail,” Piotr Matys, a strategist for emerging-market currencies at Rabobank in London, said by e-mail. “Holding third elections within less than a year would cause even more damage to an already fragile economy and would send the lira to a new all-time low.”

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