Turkey’s lira rebounded from its biggest retreat in eight years after the government thwarted a coup attempt that erupted on Friday. Bonds tumbled as the cost of insuring the country’s debt soared, while shares in Turkish Airlines and banks led a slump in stocks.
The currency gained 1.8% to 2.9627 per dollar as of 1:53pm in Istanbul, trimming Friday’s 4.6% decline, as traders said local investors were selling dollars to take advantage of Friday’s selloff.
 The Borsa Istanbul 100 Index, which had closed before the clashes began, dropped as much as 5.2%, the most in three years. Yields on 10-year government bonds jumped 60 basis points, their biggest advance since 2013.
The crisis has undermined a recovery in Turkey’s assets as inflation eased and investors became confident central banks around the world will keep pumping cash into the biggest economies. That means any rebound this week driven by bargain-hunting will probably be short-lived, given a resurgence of political risk, according to Piotr Matys, a strategist for emerging-market currencies at Rabobank in London.
“The damage has been done,” Matys said, adding that events were “seriously challenging” an earlier forecast that the lira would stay below 3 per dollar this year. “We expect Turkish assets to be vulnerable in the short term and the lira to remain volatile in the coming days. If the rule of law and checks and balances are seriously undermined in the coming months, this could lead to capital outflows.”
Implied volatility on the lira, estimating future price swings, spiked as much as 180 basis points to 12.6, the most since May.
The Istanbul index of bank shares dropped 7%, its biggest decline in more than a year. HSBC Holdings said in research published yesterday that political developments may affect lenders’ access to foreign funding. Investors also fled stocks linked to Turkey’s tourism industry, already reeling from a series of terrorist bombings across the country. Airport operator TAV Havalimanlari Holding fell 11.8%. Turkish Airlines, also known as Turk Hava Yollari, declined 9%.
Bonds also fell, with the yield on Turkey’s dollar bond due February 2045 rising 21 basis points. The cost of insuring exposure to Turkish debt rose, with five-year credit default swaps widening as much as 17 basis points to 242 after falling to a the lowest in a year last week.
Corporate bonds declined. Appliance-maker Arcelik’s €350mn of September 2021 notes dropped two cents to 102¢, according to data compiled by Bloomberg. The bonds were the biggest decliners in Bank of America Merrill Lynch’s euro-denominated junk-bond index, apart from Softbank Group Corp notes, according to data compiled by Bloomberg. Turkish bank Turkiye Vakiflar Bankasi’s May 2021 bonds fell the most since their issuance in April.
Goldman Sachs Group lowered its forecasts for the lira over the weekend, saying the currency will slide to 3.10 per dollar within three months, revising its earlier forecast of 2.95.
“While the immediate level of uncertainty has been sharply reduced post the failure of the takeover and a renewed coup appears unlikely, we expect the level of political risk will remain elevated and hence have implications for the economy,” Clemens Grafe, a Moscow-based economist at Goldman, wrote in a report.
In an effort to quell investor concern, policy makers said on Sunday they will provide unlimited liquidity to banks and would support the lira by removing limits on foreign currency deposits that commercial lenders are allowed to use as collateral. While the coup attempt may have a negative impact on Turkey, especially on tourism, reforms will now be easier to carry out, Deputy Prime Minister Mehmet Simsek said in an interview with Bloomberg HT from Ankara aired yesterday.
The central bank is scheduled to hold a policy meeting today and traders are now betting it will not cut its overnight lending rate. Swaps that gauge interest rate expectations one month from now climbed 40 basis points to just 1 basis point below the bank’s overnight lending rate of 9%.
The Turkish central bank has lowered the overnight interest rate by 175 basis points since March as slowing inflation cleared the way for looser monetary policy, supporting the rally in Turkish assets. Before the market retreat yesterday, Turkish equities had risen more than 15% during 2016. The yield on Turkish five-year local currency bonds has dropped more than every other emerging-market nation this year except for Indonesia and Brazil.
While Turkey’s economy was among the biggest beneficiaries of the global clamour for yield as central banks pump cash into economies, Friday’s coup attempt, that left some 200 dead and has been followed by massive reprisals, risks unnerving investors.
“Foreign investors currently own about 22% of the local bond market in Turkey. So this faces a significant outflow risk if investors decide that the increased political risk premium now requires a much lower exposure to Turkish assets,” HSBC said.
Thousands of army officers and judges were swept up in a nationwide wave of arrests as Erdogan and the ruling AK Party moved to cement power. While some investors express concern that the president’s quest to centralise power leaves the nation vulnerable to social unrest, others see his survival as the surest bet of stability for a Nato ally entangled in the war in neighbouring Syria and in conflicts with Kurdish separatists.
The market could demonstrate a “sanguine take on events over the weekend, given that security has been restored,” Timothy Ash, a credit strategist at Nomura. in London, said in an e-mailed note. “This could offer the prospect of a more stable political environment as a result — albeit leaving longer term concerns over the course of economic policy and democracy.”