Turkey’s currency headed for its biggest weekly depreciation since May after the central bank cut overnight interest rates for the second time this year, reducing the attractiveness of lira-denominated debt.
Governor Erdem Basci’s 25 basis-point cut sent the lira 1.5 percent lower this week, the most since a 2.9 percent retreat nine months ago, to 1.7930 a dollar, while benchmark two-year lira bonds traded within three basis points of the lowest yields on record at 5.67 percent yesterday. That compares with 8.41 percent for similar-dated Russian debt and 5.83 in Brazil.
The Turkish central bank cited “accelerating capital inflows” for reducing overnight rates by 50 basis points in the past two months and said it won’t tolerate an overvalued lira fueling imports and widening the current-account deficit. The drop in yields on lira debt means investors aren't compensated for the risks, according to Standard Bank (SBACI) Group Ltd., which revised lower its year-end forecast for the lira to 1.9 per dollar from 1.7 yesterday.
“The central bank is doing its best to change the direction of the lira and I expect the lira to plunge in the coming days,” Suha Yaygin, deputy head of emerging markets at Toronto Dominion Bank in London, said in e-mailed comments yesterday. “The central bank will cut rates to 4 percent if the lira does not depreciate further.”
The lira is likely to weaken 3.4 percent against the dollar by the end of 2013 to 1.8580, according to currency futures traded on the Turkish Derivatives Exchange. The currency forwards show the lira will weaken to 1.82 in the second quarter.
Turkey’s currency erased its gains for this year yesterday as the U.S. Federal Reserve signaled it may consider slowing asset purchases. It traded 0.6 percent lower at 1.7936 per dollar at 5:28 p.m. in Istanbul.
Several participants at the Federal Open Market Committee’s Jan. 29-30 meeting “emphasized that the committee should be prepared to vary the pace of asset purchases, either in response to changes in the economic outlook or as its evaluation of the efficacy and costs of such purchases evolved,” according to the minutes of the gathering released two days ago.
“I can very well imagine the lira moving above the 1.80 mark against the dollar,” said Thu Lan Nguyen, a currency strategist at Commerzbank AG in Frankfurt, said in e-mailed comments yesterday. The currency is unlikely to weaken beyond 1.84 per dollar because “from a fiscal point of view Turkey outshines” most European Union countries, she said.
Societe Generale SA (GLE) is making no change to its lira forecast of 1.80 per dollar for the end of March, Guillaume Salomon, an emerging-market strategist at the bank in London, said in e-mailed comments yesterday. “I still think the central bank is doing an amazing job at managing the lira,” he said.
By adjusting interest rates to control capital inflows and defend the lira, the central bank has helped reduce three-month currency swings to 4.70 percent from more than 14 percent at the beginning of last year.
The central bank raised foreign-exchange and lira reserve requirements for lenders this week, withdrawing $940 million from the market, as it seeks to limit year-on-year loan growth to 15 percent, down from 19 percent in the year to Feb. 8. It kept the benchmark one-week repo rate at 5.5 percent.
Five-year credit-default swaps on Turkey rose three basis points to 137 yesterday. That’s still less than the cost of 146 for Russia and 169 for South Africa, even though both nations have better credit ratings. Rising prices indicate worsening perceptions of creditworthiness. The contracts pay the buyer face value in exchange for the underlying securities or cash equivalent if a borrower fails to adhere to its debt agreements.
The extra yield investors demand to hold Turkey’s dollar debt over U.S. Treasuries jumped 10 basis points, or 0.1 percentage point, to 204, according to JPMorgan Chase & Co. (JPM:US)’s EMBI Global Diversified Index. Turkey’s spread is 72 basis points below the average for emerging markets, compared with a discount of 89 at the end of last year.
“The risks are now biased to the downside,” said Tim Ash, the London-based chief emerging-market economist at Standard Bank. The drop in yields on lira debt means “investors are not being paid for the risks,” he said.
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