Turkey's Lira Leads Carry Trade Revival as Investors Ignore Risk

  • Lira's volatility-adjusted yields top other major currencies
  • Carry trading rebounding after biggest losses in four years

Turkey, grappling with terrorist attacks and a refugee crisis, is emerging as an attractive destination for currency investors as carry trades show signs of recovery following the biggest losses in four years.

The volatility-adjusted yield on the lira, a measure of investment risks versus rewards, is the best among the world’s most-traded currencies after it rose to the highest since May 2014. Carry trades, where investors buy higher-yielding assets with funds borrowed in lower-interest-rate countries, are popular again as a dovish Federal Reserve and a nascent Chinese recovery help quell volatility in foreign-exchange markets, boosting appetite for riskier assets.

The lira has gained 3 percent in the past three months, underscoring the allure of overnight interest rates of as much as 10 percent in a world where $8 trillion of developed-market government bonds yield less than zero. Turkey is struggling with an influx of refugees from Syria, a conflict with Kurdish separatists and an upsurge in Islamist terrorism. Meanwhile, President Recep Tayyip Erdogan has been criticized by the European Union for clamping down on opponents and questions have been raised over the central bank’s independence.

The currency depreciated 1.1 percent on Tuesday after Turkey’s parliament moved closer to putting dozens of pro-Kurdish lawmakers on trial for supporting terrorism, triggering fist-fights in the assembly and warnings of a further spike in separatist violence.

‘Risk-On Environment’

“The global backdrop for yield seeking and carry trades has been improved,’’ said Arnab Das, London-based head of emerging-market macro at Invesco Ltd., which oversees $741 billion in assets. “The Turkish lira has been among the beneficiaries. The negatives on politics are being outweighed for now by the mix of a more supportive global risk-on environment,’’ he said while declining to comment on the firm’s positioning in the lira.

After a disastrous 2015, carry trades are bouncing back, fueled by stimulus packages from China and the Fed’s pledge to raise rates gradually. A UBS AG benchmark which measures the performance of the strategy rose 0.6 percent in April, erasing its losses for the year. The gauge fell 9.3 percent last year, the most since 2011.

“We’re in a sweet spot for carry where you can try to find those high-yielding currencies that have a decent fundamental story and a relatively high yield,” said Brad Bechtel, a currency strategist at Jefferies Group LLC in New York. “Things like India and Turkey jump out.”

No Haven

Turkey may not yet be an investment haven when compared with India, the fastest growing major economy. Spillover from Syria’s civil war has taken its toll on the country as the autonomy-seeking Kurdish group PKK resumes fighting against Turkish forces and the Islamic State steps up its attacks. The PKK is classified as a terrorist organization by Turkey, the U.S. and the EU.

Erdogan has repeatedly called on the central bank to cut borrowing costs to lift the economy even as inflation remains above the policy target. Central bank Governor Murat Cetinkaya, who took office in April, has pledged to curb inflation, which slowed for a third month.

Michael Hasenstab, who oversees $124 billion as chief investment officer at Franklin Templeton in San Mateo, California, is among those investors who are bearish on Turkish assets. In an interview posted on Youtube.com last week, he singled out Turkey as a country “in legitimate crisis” on account of a “bad policy mix,” along with Russia, South Africa and Venezuela.

EU Membership

Such concerns haven’t deterred other traders from moving back into the country. Foreign investors bought $2.38 billion in lira-denominated bonds this year, the most for the period since 2013.

The lira isn’t the top carry-trade performer this year. Borrowing the dollar and investing in the lira has returned 6.7 percent, compared with 17 percent in the real and 18 percent in the Russian ruble. But the lira’s volatility is falling faster than for any other major currency, making it more predictable for investors to pick up the interest-rate differences in Turkey.

The so-called carry-to-volatility gauge for the lira, measured by the ratio between three-month implied yields in currency forwards and implied volatility, increased to 0.9 on April 29, from 0.78 at the end of 2015. That compared with 0.65 for Brazil’s real and 0.41 on South Africa’s rand.

Capital is flowing back into Turkey as the EU is supporting the country’s bid for membership in exchange for help in controlling the flow of Syrian refugees. That has added to the positive momentum after the plunge in global commodity prices helped narrow the nation’s current-account deficit. The shortfall in Turkey, a net energy importer, shrank to 4.5 percent of economic output last year, the lowest since 2010.

“The lira has been very resilient, largely due to soft oil prices aiding with steady adjustment in the current account,’’ said Roxana Hulea, a London-based emerging-market strategist at Societe General SA, who recommends buying the lira versus rand. “I still prefer the lira’s favorable carry-to-vol characteristics to navigate the benign sentiment.’’

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