VIEW_ Islamic State Deepens Lira Bond Investor Gloom: Turkey Credit

Bloomberg

Islamic State Deepens Lira Bond Investor Gloom: Turkey Credit

By Selcan Hacaoglu
Sep 30, 2014 7:00 AM ET


Add Islamic State, the militant group tearing through Iraq and Syria, to the list of troubles rocking Turkey’s bond and currency markets.

The yield on 10-year government bonds climbed above 10 percent for the first time since April yesterday amid speculation Turkey will soon join the U.S.-led military campaign against the al-Qaeda breakaway group. The lira weakened to the lowest level in eight months, making it the worst performer among 10 developing-nation currencies in the region tracked by Bloomberg.

Turkey deployed tanks along the border with Syria as fighting between the Islamists and Kurdish groups intensified. The nation’s bonds and currency were already set for monthly declines, as inflation is forecast to stay above 9 percent for the sixth straight month in September and concern mounts the U.S. may be advancing the timetable for raising interest rates.

“The geopolitical storm surrounding Turkey remains unabated,” said Phoenix Kalen, director of emerging-markets strategy at Societe Generale SA in London. “This factor will exert upward pressure on bond yields until a more stable solution regarding Islamic State is reached.”

The yield on Turkey’s 10-year local currency bonds surged as much as 37 basis points yesterday. The lira weakened 0.8 percent to 2.2807 per dollar at 11 p.m. in Istanbul.

Other emerging-market currencies have also dropped, as speculation grows that the U.S. Federal Reserve will raise U.S. interest rates next year. For Turkey, that prospect is compounded by the region’s political tensions.

Turkish Assistance

Islamic State’s offensive against the Kurdish-held town of Kobani in northern Syria has sparked an exodus of tens of thousands of Syrian Kurds, and raised concerns that fighting will spill over into Turkey.

Turkey supports establishing a secure area inside Syria to help refugees return, President Recep Tayyip Erdogan says. Erdogan said Sept. 28 that his country “can’t stay out” of the coalition against Islamic State.

Kurds in Turkey suspect Erdogan wants to create a militarized buffer zone along part of the Turkey-Syria border to smother the autonomous Kurdish region in Syria. The Turkish government, whose peace overtures toward its own Kurdish minority have been strained by Islamic State’s campaign, denies supporting the militant group.

‘Peace Process’

Not acting against Islamist State “could undermine the Kurdish peace process in Turkey,” Timothy Ash, chief emerging-markets economist at Standard Bank Group Ltd. in London, wrote in a note yesterday. “Acting could risk terror attacks back in Turkey, and across its long border with both Iraq and Syria.”

Turkey’s central bank, under pressure from Erdogan to prioritize the economy, has lowered its benchmark one-week repurchase rate to 8.25 percent in three steps starting in May. While saying inflation warrants tight monetary policy, the bank said Sept. 25 that new data could lead it to “revise its stance.”

The combination of “troubling geopolitical” events and a shift in investor appetite toward emerging markets have focused the attention of investors on the “inadequacy” of the central bank’s moves to curb inflation (TUCPIY), said Kalen of Societe Generale.

Inflation quickened to 9.54 percent in August, almost twice the central bank’s target. Data released on Oct. 3 may show that the annual rate dropped to 9.38 percent in September, according to the median estimate of 12 economists on Bloomberg.

Inanc Sozer, chief economist at Odeabank AS in Istanbul, said investors will likely wait until “they see a real improvement in inflation” before they turn more positive on Turkish assets.

“Uncertainty over Syria and Turkey’s plans to join the coalition against Islamic State and create a buffer zone along the border adds to its risk premium,” he said.

To contact the reporter on this story: Selcan Hacaoglu in Ankara at shacaoglu@bloomberg.net

To contact the editors responsible for this story: Alaa Shahine at asalha@bloomberg.net Mark Williams

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