How the might of monetary policy doves can prevail in Turkey's markets

Istanbul

ANYONE doubting the extent to which monetary policy doves in the US and Europe are buttressing the world's markets should look no further than Turkey.

The nation's freshly appointed central bank governor bowed to calls for lower interest rates from President Recep Tayyip Erdogan and delivered a record 425-basis-point cut last Thursday, just minutes before the head of the European Central Bank set out the case for a new wave of stimulus.

Instead of unleashing a sell-off, however, traders were witness to an explosive rally in Turkey's local bond and swap markets after the rate reduction. The lira, meanwhile, bucked a rout in emerging markets last week, and was poised for its third daily advance against the dollar last Friday.

"It's the trade to be in over the next few weeks," said Christian Wietoska, a London-based strategist at Deutsche Bank AG.

The lira remained "surprisingly stable" after the central bank cut borrowing costs, which is "extremely positive" for the rates market, he said.

Even after its key rate was chopped down, Turkey's lira remains one of the highest-yielding currencies in emerging markets. In a world hooked on central bank stimulus and plagued by US$13 trillion of negative-yielding debt, that amounts to a licence to loosen without risking an immediate reckoning with a weaker currency.

As investors piled on bets for further rate cuts, the yield on Turkey's two-year notes broke below 17 per cent last Friday for the first time since May 2018.

Meanwhile, the Turkish lira cross-currency swap curve continued to steepen, taking the spread between one- and five-year tenors to just over 100 basis points, extending a rally from a peak of almost 1,000 points seen in March.

"On the currency front, I was expecting some underperformance, but it was short-lived," because the lira was supported by bond inflows, said Esther Law, an investment manager for emerging-market debt at Amundi Asset Management in London.

Turkey's rate cut is "positive for short-dated Turkish bonds while the long end part of the government curve will be more sensitive to future inflation data," she said.

That's not to say that Turkish assets are out of the woods. After Turkey's rate decision, the European Central Bank signalled the need for significant stimulus as the growth outlook deteriorates, denting risk sentiment.

The currency was 1.1 per cent stronger at 5.6314 per dollar as of 4.30pm in Istanbul after unwinding some of its advance following the central bank's meeting. Gains even picked up after Mr Erdogan said the rate cut was "not enough" and urged the central bank to proceed with gradual monetary easing.

"What happened after" the rate cut, Mr Erdogan asked last Friday during a speech in Ankara. "Did Turkey go bankrupt? Everything collapsed? Markets responded normally."

The latest central bank data shows foreign investors' share in the local-currency bond market remained near a record low of around 13 per cent. For some, that's one more sign that the market is now due for a rebound, even as the central bank loosens policy.

"Our view is that the lira should continue to outperform during the summer," Mr Wietoska at Deutsche Bank said.

"Importantly, real rates are likely to remain positive throughout the remainder of 2019. Our sense is that foreign positioning in Turkish assets remains very light." BLOOMBERG