Markets Brace for Volatility as Turks Mull Erdogan's New Powers

  • Polls show vote on constitution change still too close to call
  • Measures of lira volatility surge to highest since January

As Turkey’s 58 million eligible voters get ready to decide whether to hand more power to President Recep Tayyip Erdogan, investors are bracing for what promises to be a very close race.

Pollsters have reported too many undecided voters to accurately forecast the result. While the proposed changes to Turkey’s political system would be transformational, it’s less clear how they would alter the nation’s economic trajectory.

Sunday’s vote comes on the heels of a difficult start to the year that saw the lira drop to record lows. Markets cheered the central bank’s unorthodox attempts to stabilize it, but the currency remains 2017’s worst-performer among its major peers.

With only four days to go until the ballot, here’s a glance at how investors are positioned:

For more on the possible outcomes of Turkey’s referendum, read this story.

Exchange-Rate Volatility

Options contracts shows traders are hedging against price swings in the lira, particularly in the immediate aftermath of the vote. European markets will be closed on Monday and the reduced liquidity could accentuate any moves. On Monday, the week-ahead volatility gauge registered its sharpest surge since Jan. 11, the day the currency fell to a record low against the dollar.

Locals’ Deposits

As Turkey’s currency recovers from January’s selloff, local households and businesses have been busy rebuilding their foreign-exchange holdings. They scooped up $5.5 billion-worth of hard currency in the four weeks through March 31, increasing foreign-denominated savings to $153 billion. While the central bank only reveals residents’ activity with a lag, which side of the trade they take next week can accentuate or smooth out moves in the currency.

Short Bets

Some investors are protecting against the prospect of a drop in the Istanbul stock index, which has been hovering near two-year highs. As of Monday, short interest on New York-traded iShares MSCI Turkey exchange-traded fund jumped to 12.5 percent of shares outstanding -- the highest level since October, according to IHS Markit data.

Staying on the Sidelines

For the time being volatility in stocks remains subdued, suggesting a lack of conviction over the referendum outcome. Thirty-day volatility on the index fell to the lowest level since January 2013 before registering a moderate jump on Monday, as the benchmark Borsa Istanbul 100 Index capped its second-best day of the year.

Buying Bonds

Foreign investors are also starting to dip back into local debt markets. They were coaxed along by the central bank, which stepped in to support the lira with higher interest rates and helped mitigate some of the uncertainty around the vote. Offshore funds have pumped the equivalent of $913 million into lira bonds in the past month, even while they’ve been net sellers of equities. Foreigners’ share of the local bond market had dipped to a five-year low earlier this year, with investors scared off by the crackdown that followed the failed coup attempt, as well as by credit-rating downgrades and the lira’s slump.

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