Thanksgiving came early for Turkey, but investors in the country’s local debt will not have been grateful to see its currency roasted.
Earlier this month, the US suspended handling all regular visa applications for Turkey following the arrest of a member of staff at the American consulate in Istanbul. The Turkish lira quickly lost almost 7% against the US dollar, slumping to an eight-month low.
Should tensions persist and the lira remain weak, holders of locally denominated Turkish debt will suffer. This group includes all of the five best funds in the Emerging Markets Local Currency Debt sector over the past three years.
While Turkey makes up just 4.7% of the main JPM EM Local Currency Bond index, the Eaton Vance Emerging Markets Local Income and Emerging Markets Debt Opportunities funds have allocations to the lira of 9.2% and 4.9% respectively.
The TCW Emerging Markets Local Currency Income fund has 9.8% in the lira, the T. Rowe Price Emerging Markets Local Currency Bond fund has 5.5%, the Prudential Emerging Markets Debt Local Currency fund has 9.1%, and the Hartford Emerging Markets Local Debt fund has 7.9%.
Gobbling it up
Despite the recent turmoil, the bond markets have taken plenty of other troubling headlines about Turkey in their stride. For example, in April, president Erdogan won considerable new powers in a major constitutional referendum.
‘While the reaction from Berlin, Brussels and Paris has been uniformly negative, Turkish assets reacted positively to the lessening of near-term political risks and an acceleration in local economic activity,’ said Prudential’s David Bessey and Cathy Hepworth, both + rated by Citywire.
‘We continue to be positive on Turkish assets due to their compelling relative value,' the pair added. 'The Turkish lira is second only to the Mexican peso in real effective exchange-rate cheapness, and the hawkish central bank is keeping the carry close to 11.5%. Similarly, local bond yields are near the top of their post-2008 range, and we expect inflation to roll over in early 2018.’ Bessey and Hepworth therefore view Turkey as a candidate for rate cuts.
Likewise, TCW’s Penelope Foley and David Robbins increased their exposure to Turkey in the second quarter of this year. ‘We shifted to an overweight position in Turkey on the back of lower near-term political risk, a benign Fed outlook and lower oil, against an underweight in Russia as the ruble was trading on the expensive end of the range,’ they explained. The team has subsequently closed that Russia underweight.
‘Global liquidity will likely moderate gradually this year due to US Fed tightening, but developed-market central bank policy will remain broadly accommodative in our view,’ they argued.
‘Emerging-market fundamentals are improving against a broadly constructive global backdrop, though risks remain around oil prices. We have begun to see a U-shaped growth recovery for emerging-market countries. Despite this overall constructive picture, not all countries are moving at the same pace and direction, so country differentiation will be important.’