Turkey — FX carry is back … After a long period of unorthodox policy, escalating imbalances and reduced investor interest, Turkey’s accelerated path towards rate normalisation continued last week, with another large hike taking the policy rate to 30%. The forward guidance noted that monetary tightening will be strengthened further and there is a clear focus on incentivising local market participants to switch from FX-protected deposits to TRY deposits. The recent increase in policy rates suggests that deposit rates are likely to increase further, and while implementation risks clearly remain, the recent articulation and support of a positive real rate strategy – in sharp contrast to previous years – suggest that it may be possible to beat the FX depreciation reflected in forward pricing again, implying that the Lira carry trade is back.
… paired with inexpensive credit hedges. Meanwhile, Turkey credit spreads have been even quicker to price the return to more conventional monetary policy. Turkey USD bond spreads are now significantly tighter than the EMBI Global Diversified benchmark index for the first time in years, and both the cash and CDS curves have steepened. By our estimates, Turkey’s USD bond spreads have traded increasingly on idiosyncratic developments and are now largely pricing an improvement in institutional quality and inflation expectations returning to ~10% or less. Unlike FX, this suggests that Turkey credit is already pricing a more positive macroeconomic outcome, rendering it an inexpensive hedge against FX longs. For the long-only credit investor, being overweight Turkey credit offers a less attractive risk / reward, as the current pricing provides little upside or downside protection should the policy momentum suddenly turn. Moreover, it is worth noting that Turkey’s technicals are likely to be challenged by a high maturity profile in the coming years which will need to be rolled over with new issuance.
Turkish Bank equities — A ‘derivative’ trade of FX. Year-to-date, Turkish equities have seen a remarkable rise (+50%), offering one of the strongest equity returns across the globe. However, most of these gains have been based on FX pass-through, given that the Turkish Lira has depreciated 46%, meaning that the USD return on Turkish equities has been about 3% year-to-date (underperforming EM ex-China’s 6% gains). Given low nominal valuations of MSCI Turkey (5.8x P/E), a further macro re-rating could provide a potential bullish signal for equities going forward; however, exporters (with a large 30.6% weight in the index) would likely underperform if the currency stabilises from here.
Rather, we think investors looking for a bullish angle within Turkish equities should consider the Banks, which are likely to outperform meaningfully (after years of lagging exporter peers) if the TRY stabilises on some return of monetary policy confidence.
EM local rates: Local disinflation under pressure from global headwinds. Hawkish pressures from higher US rates, rising oil prices and weaker EM currencies explain to a large extent the sell-off in EM-15 rates. Despite these headwinds, we think that EMs can continue to disinflate and that the hawkish pressures are more likely to curtail the speed of EM rate cuts, rather than derail the cutting cycles as a whole. We continue to like relative value expressions in this environment, where we think the market is underpricing the improvement in the underlying inflation picture, and we reiterate our recommendation to receive 5Y IRS in Hungary vs pay 5Y in Czech, receive 2Y Mexico vs pay 2Y Chile, as well as to fade the market pricing of rate hikes in India by receiving 1Y ND-OIS.
Excerpt from Goldman Sachs EM Trader publications
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