Some of the world’s largest investors are cautiously considering the unloved Turkish bond market, which could emerge as the standout bright spot in the $8 trillion local debt universe of developing nations in 2024. Despite the allure of record-high yields, investors remain cautious.
With President Recep Tayyip Erdogan’s ongoing economic policy overhaul, prominent money managers such as Amundi SA, managing $2 trillion, are advocating for Turkey to raise interest rates further and possibly allow for a weaker currency to rekindle investor interest in lira bonds.
Despite five consecutive rate hikes, Turkey’s official borrowing costs remain below the central bank’s projected year-end inflation rate. Policymakers have signaled that more rate increases are on the horizon.
The outcome could translate into potential billions of dollars in bond inflows for Turkey, the world’s fifth-largest developing economy outside Asia. As Turkey’s central bank rate has already more than quadrupled to 35% since June, entities like Amundi and Itau Asset Management are calling for a further increase of 5 to 10 percentage points, a level predicted to be reached this quarter by some economists.
Scott Grimberg, head of emerging market debt at Itau Unibanco Holding SA’s asset-management arm, suggests that “if policymakers can maintain a 40% or higher policy rate and the lira can remain broadly stable for a few months… lira bonds will become very attractive for foreign investors.”
With Turkey’s 10-year government bonds trading at 28.4%, foreign investors’ return could be brought closer to the redemption story. Non-resident holdings are still meager at $1 billion, significantly down from a peak of over $70 billion a decade ago.
However, Turkey’s government local-currency bonds have been the worst performer in emerging markets since the end of May. Turning investor sentiment toward Turkey relies on raising rates to at least 40-45%, coupled with a weakening lira, and stabilizing inflation that currently hovers near 62%.
Market Distortions and Skepticism:
Turkish lira bonds have faced unique challenges, distorted by Erdogan’s unconventional economic policies that used them for various goals. A series of regulations, which partially eased last month, suppressed yields on government debt, making foreign investors wary.
Despite a shift towards more conventional policies post Erdogan’s re-election in May, Turkey’s benchmark 10-year bond rates have surged by over 20 percentage points to an all-time high of around 30%. However, even in a global context where yields on emerging-market bonds in local currencies have closely aligned with US Treasuries, Turkey’s rates are not yet sufficiently attractive for most investors.
JPMorgan Chase & Co. strategists have indicated a fair value of around 35.7% for the 10-year lira notes before they consider investment. Market participants are watching Erdogan’s new economic team, Finance Minister Mehmet Simsek, and central bank Governor Hafize Gaye Erkan, to see if they can help attract investors.
Foreign investors remain concerned about the restrictions in the offshore lira swaps market. Timing for entry also depends on Turkey’s domestic political cycle, as a local election scheduled for March may influence economic policy choices. The greatest variable remains Erdogan’s role, given his history of ousting central bank governors.
Societe Generale SA remains optimistic if the economic team can set Turkey’s economy on the right path, and Van Eck Associates Corp. senses an opportunity if past policies continue to unwind. David Austerweil, deputy portfolio manager at Van Eck, said, “With only local elections ahead, it lowers the risk for another swift policy change in the near term.”
The outlook for Turkey’s bond market appears hopeful but is conditioned upon a series of factors, from interest rates and currency performance to broader policy and geopolitical dynamics, all of which will shape Turkey’s economic prospects in 2024.
