Bloomberg News

JPMorgan Says Bond Rally Over on U.S. Correlation: Turkey Credit

August 16, 2012

Turkey’s lira bonds are moving increasingly in tandem with U.S. Treasuries in a sign to JPMorgan Chase & Co. that the best bond rally in eastern and central Europe is ending.

The correlation between Turkish and U.S. 10-year bonds has climbed to 0.86 from minus 0.3 in January, according to data compiled by Bloomberg in which 1 shows movement in lockstep while minus 1 indicates opposite directions. Turkey’s 10-year yields climbed 45 basis points from a record low 8.08 percent on July 19, while U.S. rates rose 42 basis points from an all-time low on July 25. Turkey’s debt has returned 11 percent in the past five months, outperforming a 3 percent gain for U.S. notes, according to Bank of America Merrill Lynch global indexes.

Investors are selling U.S. Treasuries on signs of an improving economy and may do the same with Turkish bonds, JPMorgan said, prompting it to cut its outlook on Turkish debt to neutral from outperform on Aug. 13. That’s a change from five months ago, when yields on the two countries’ debt moved in opposite directions as signs of a strengthening global economy sent investors rushing to higher-yielding emerging markets like Turkey, while poor economic data led to sell-offs in emerging markets as investors sought the relative safety of U.S. debt.

“Flight to quality used to mean weaker emerging market currencies and weaker bonds, but the link seems to be broken now,” Caroline Gorman, who helps manage $6.8 billion in emerging-market debt at GAM International Management Ltd., said in an e-mail from London yesterday.

Economic Outlook

While the same trend is being seen across emerging markets from South Africa to Mexico, Turkey’s sensitivity to moves in Treasuries is now among the highest in emerging markets, with a beta of 0.4, compared with the emerging-market average of less than 0.1, according to JPMorgan. That’s a concern for the New York-based bank as U.S. Treasuries sank to the lowest in three months. A beta measurement shows the degree to which a fund or security fluctuates relative to a benchmark gauge.

Turkish bonds outperformed this year on investors’ expectations that the country’s slowing economy, the biggest in the Middle East and eastern Europe outside Russia, would help reduce inflation and narrow the nation’s record current account deficit. Foreign bond investors raised their stake in Turkish debt to a record high, according to data from the central bank published on Aug. 9. That’s also a risk, according to JPMorgan, as they may now look elsewhere for better relative returns.

Treasury Yields

“The risk versus reward of staying long looks less attractive at current yields,” JPMorgan said in a report on Aug. 13. The outperformance of Turkish government bonds this year, along with the market’s correlation to U.S. Treasuries and high proportion of foreign ownership of Turkish bonds, increase the “vulnerability of the market on any further Treasury sell- off,” it said.

Yields on 10-year U.S. Treasuries jumped to a three-month high of 1.86 percent yesterday from 1.39 percent on July 24 as improving jobs, consumption and factory production data this month damped speculation of monetary stimulus from the Federal Reserve. The increase narrowed the yield spread of Turkish 10- year bonds over Treasuries to 6.77 percentage points, down from a high of 8.31 percentage points on Jan. 2, according to Bloomberg data.

Real yields on Turkish debt, calculated by adjusting for inflation expectations, have slumped to negative 2.6 percent in 2012 from positive 10.1 percent in 2007, according to a report yesterday by Ashraf El Ansary, founder of Exante Strategies LLP in London, an investment consultancy.

Risk Premium

Turkey’s risk premium over Germany has compressed, according to data on credit default swaps. The spread on Turkish swaps over Germany tumbled 110 basis points, or 1.10 percentage point, to 123 basis points yesterday from a 2 1/2-year high on Jan. 9, indicating the perception of Turkey’s creditworthiness relative to Europe’s biggest economy is improving.

“There is still a lot of risk in emerging markets,” Luis Costa, a strategist at Citigroup Inc. in London, said by e-mail on Aug. 15. A deterioration in fiscal and debt conditions in developed countries “is pushing funds to emerging markets more and more,” he said.

The extra yield investors demand to hold Turkey’s dollar- denominated sovereign bonds rather than U.S. Treasuries climbed 1 basis points to 225 yesterday, JPMorgan Chase & Co.’s EMBI Global index shows. That compares with the average spread among emerging markets of 311.

Core Markets

Yields on benchmark two-year Turkish bonds dropped 20 basis points yesterday to 7.74 percent, the biggest decrease since February, as the central bank said it could ease policy by narrowing its so-called interest rate corridor. The lira gained 0.2 percent against the dollar to 1.7958 at 6:50 p.m. in Istanbul, extending its gain on the year to 5.3 percent, the fourth-best performance among the 31 most-traded currencies tracked by Bloomberg.

Turkish central bank Governor Erdem Basci varies interest rates daily between 5.75 percent and 11.5 percent to balance inflation, growth and the value of the lira. He’s used the rate to gradually cut the average cost of funding to the country’s banks by almost half to 6.9 percent yesterday from an all-time high of 11.9 percent in January.

The U.S. Federal Reserve has held its target for overnight lending in a range of zero to 0.25 percent since 2008 to stimulate the world’s biggest economy.

“Low yields in core markets have encouraged flows into a variety of emerging markets,” GAM’s Gorman said. “I think rising U.S. Treasury yields are a risk for emerging markets generally.”

To contact the reporter on this story: Benjamin Harvey in Istanbul at

To contact the editor responsible for this story: Gavin Serkin at

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