Turkish Assets Seen in Limbo as Erdogan Loses Key Cities in Vote

(Bloomberg) -- Turkey's financial markets look to be headed for a rough ride after early results of local voting showed it may be the first time since 1994 that President Recep Tayyip Erdogan or an affiliated party have lost support from the nation's largest city, investors and analysts say.

The Turkish lira sank 1.9 percent on Monday to 5.6762 per dollar as of 10:47 a.m. in Istanbul. Overnight swap rates climbed and stocks retreated.

Read: Turkey Election Board Says Opposition Leading Race in Istanbul

What investors are saying about the results so far and the impact on markets:

Damien Loh, chief investment officer at Ensemble Capital Pte Ltd in Singapore:

• The results were better than feared but not a wholehearted endorsement of Erdogan given he did well in the overall election but lost key cities
• USD-TRY may trade stable to slightly lower on Monday, but for the medium term, it should head higher as the underlying reasons for the weakening of TRY remains
• Markets will start focusing on the geopolitical tension between Ankara and Washington that's heating up again given the refusal of Turkey to back down from purchases of the Russian-made missile defense S-400, and U.S. not willing to transfer the F-35 jets
  • Read: U.S. Senate Approves Freeze of Arms Sales to Turkey on S-400

  Elsa Lignos, global head of currency strategy at RBC Capital Markets in London:

  • With no elections until 2023, all focus will be on policy direction. But losses in Turkey's two largest cities may limit Erdogan's appetite for reform and keep weighing on the lira

  Patrick Wacker, fund manager at UOB Asset Management Ltd. in Singapore:

  • Though Mr. Erdogan will not face a vote for up to four years, high profile losses, particularly Ankara, could potentially spur the government into a more expansionary fiscal policy, which would further stoke already high inflation
  • With the elections over, we may continue to see a relief rally in dollar bonds that started with improving EM sentiment Friday. The concerns I have with Turkey are less related to election noise: after elections last year the central bank returned to fairly orthodox policies, despite Erdogan's rhetoric to the contrary
  • Beyond a relief rally we remain cautious on Turkish bonds, due to potential increasing headline risk of a U.S.-Turkey standoff over Russian weapons deliveries, with likely follow on U.S. sanctions that would be a further setback to Turkey's recession-weakened economy

  Tatha Ghose, a senior emerging-market at Commerzbank AG, in London:

  • Sunday's election outcome strengthens our concern regarding the political fallout of the low growth environment, and about how tight the underlying monetary policy stance will remain, going forward
  • If the government becomes impatient to boost lending, this would create negative lira dynamics

  Tetsuya Yamaguchi, chief technical analyst at Fujitomi Co. in Tokyo:

  • The election results will probably lead to speculation President Erdogan will take populist measures to regain his support, which would further weigh on the nation's fiscal position, and that would be a negative for the lira and Turkish assets
  • Expectations for the Federal Reserve's pause on rate hikes amid concern about a global economic slowdown would probably make investors selective in their investment destination and Turkey may be among those suffering because its economy is already contracting and the country faces twin deficits of fiscal and current-account positions
  • Turkey's monetary policy is also in a severe situation because if the central bank would cut rates to support the economy, the lira may be sold off, but if they raise the benchmark rate, that would further hurt the already weak economy

  Saed Abu Karsh, the co-founder of Dubai-based hedge fund Ark Capital Management:

  • The case for long positions in Turkish assets is still quite poor. Turkey is still flashing red signals on pretty much every early warning indicator
  • Restrictions on the lira mean a bad situation can get a lot worse as it implies putting capital control on a country with a current account deficit, meaning a recession is more likely so equities and bonds likely to under-perform and growth will probably get worse
  • Rate cuts could happen in the third quarter, “however if USD/TRY appreciates markedly, I think that would be in doubt”

  Jameel Ahmad, the global head of currency strategy and market research at FXTM in Limassol, Cyprus:

  • Investors will be monitoring how the ruling AKP party concedes lost influence in key cities “and this will help determine whether investors are prepared to jump back into what are still massively oversold markets on a historical basis”
  • Focus is also on the central bank's next steps. With pressure on inflation easing, “an interest-rate cut towards the end of the second quarter is also something that can't be ruled out at this stage”
  • “Whether macro-economic conditions are able to improve over the coming months and how Turkey is able to combat the challenging external headwinds that are impacting other emerging markets will also influence how Turkish markets respond”
  • EM currencies were gaining versus the dollar on Monday, including the South African rand, “which is generally viewed as the ultimate proxy towards investor appetite to take on risk”; shows that investors aren't discouraged by the election outcome, and are adding risk to their portfolio

  Lysu Paez-Cortez, the senior economist at Natixis in Paris:

  • After the weekend vote the Erdogan government “will not have to contest any other election for four years. The question now is whether the government will have the resolve needed to push through the reforms that will put the Turkish economy back on its feet”

  --With assistance from Constantine Courcoulas, Yumi Teso, Filipe Pacheco and Abeer Abu Omar.

  To contact the reporter on this story: Lilian Karunungan in Singapore at lkarunungan@bloomberg.net

  To contact the editors responsible for this story: Tomoko Yamazaki at tyamazaki@bloomberg.net, Alex Nicholson

  ©2019 Bloomberg L.P.

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