The bond market’s big wager that Turkey will return to economic orthodoxy faces its first major test later on Thursday, and some investors are bracing for disappointment.
Caution has crept in after Mehmet Simsek, the former investment banker who returned as Turkey’s economic czar this month, signaled that he favors gradual moves to more conventional policies to avoid risks of a sudden adjustment. Many are taking that as a sign that the central bank may not raise interest rates as sharply as markets have been predicting since President Recep Tayyip Erdogan overhauled his economic team in the wake of an election win in May.
A senior Turkish economic official, who asked not to be named because of the sensitivity of the issue, cautioned that the jumbo interest-rate hikes being priced by the market may not materialize on Thursday. The official, who’s involved in top-level discussions on monetary policy but isn’t on the committee that sets interest rates, said the roadmap for normalization in monetary policies will be balanced, soft and sustainable in order to achieve the central bank’s price stability objective.
“Investors will be disappointed and underwhelmed by what is delivered,” said Paul Greer, a London-based portfolio manager at Fidelity International, which remains underweight Turkish assets. Simsek’s comments indicate “the new economic team have somewhat limited political capital and influence to deliver fast and far-reaching reform and provide a much-needed boost of market credibility.”
After a four-week advance, Turkey’s dollar bonds are among the biggest losers in emerging markets this week. And the cost to insure the nation’s debt from potential default has increased after touching the lowest level since 2021 a week ago.
The central bank’s decision on Thursday will be its first under newly appointed Governor Hafize Gaye Erkan, who worked for nearly a decade at Goldman Sachs Group Inc. Economists’ forecasts for the one-week repo rate are wide, ranging from Goldman’s call for a hike to 40%, to Standard Chartered Plc’s 14%. Even the lowest estimate, though, would mark a steep increase from the current rate of 8.5%.
Investors have been pinning their hopes on Simsek and Erkan to reverse Erdogan’s unconventional economic policies and his insistence on ultra-low interest rates, which have helped fuel the worst inflation crisis in decades and repelled foreign investors that Turkey relies on to plug its perennial current-account deficit.
“The early signs for Turkey’s policy pivot look promising, as highlighted by the fresh faces now in the country’s top economic positions,” said Selva Bahar Baziki, Turkey economist at Bloomberg Economics. In a piece published on Thursday, she said she expected Turkey’s policy rate to be hiked by 650 basis points to 15%.
READ MORE: TURKEY PREVIEW: Policy Pivot Set to Begin With 650-Bp Hike
“Markets operate under the assumption that Simsek and Erkan will have a free hand in conducting economic policy,” said Viktor Szabo, an investment director at Abrdn in London. “Any indication which undermines this assumption could hurt the markets and the first signs are especially important.”
After Simsek’s comments reined in the market’s optimism for a policy pivot, the risk premium on Turkey’s dollar debt widened 23 basis points this week to 471 basis points over US Treasuries on Wednesday. The spread had narrowed by about 180 basis points in the previous four weeks, according to a JPMorgan Chase & Co. gauge.
The cost to protect holders of Turkish bonds against the threat of default over the next five years also widened, to around 495 basis points on Wednesday. The credit-default swaps hit 475 last week, the lowest since November 2021.
“The credit market has priced a sharp U-turn in policies after Simsek’s appointment,” said Kaan Nazli, a London-based money manager at Neuberger Berman, which holds Turkey’s bonds. “In case of a lower-than-expected hike, it likely causes a disappointment in the CDS and eurobond markets.”
Erdogan has chased out three central bank governors since 2019 in pursuit of lower interest rates, and Erkan is the fifth occupant of the job in four years. She replaces Sahap Kavcigolu, who implemented the president’s unorthodox theories and cut interest rates even as inflation soared toward triple digits.
For AllianceBernstein’s Okan Akin, potential appointments to other positions at the central bank and its guidance on the policy outlook are more important than the rate decision itself.
“That will show investors that the monetary policy decisions are going to be taken independently,” the London-based emerging-market credit analyst said.
Aside from the new governor, the four other members of the monetary policy committee have kept their seats.
The options market is betting that the central bank will raise the policy rate to above 25% at the June meeting and about 28% by the end of the year.
“The markets may be too optimistic in pricing a return to policy normalization for Turkey and could be disappointed,” Citigroup Inc. strategists including Luis Costa said in a report this week.
(Updates with information from Turkish official in third paragraph, Bloomberg Economics comment in eighth, updates prices.)
Author: Netty Ismail, Kerim Karakaya and Firat Kozok
