Turkish Lira's Resilience Draws Foreign Investors, Analysts Optimistic

Key Takeaway

• Bank of America projects nearly 10% returns on Turkish lira through carry trade, driven by high summer tourism revenues and tight monetary conditions.
• Foreign investors have poured $5.5 billion into lira-denominated Turkish government bonds over the past four weeks, boosting non-residents' holdings to the highest level since February 2021.
• Citigroup strategists are optimistic about Turkish assets, citing potential "renaissance moment" contingent on central bank's success in re-anchoring inflation expectations.

Turkish Lira's Strong Performance

The Turkish lira has emerged as a standout performer among currencies in Eastern Europe, the Middle East, and Africa, according to Bank of America Corp. strategists. They project potential returns of nearly 10% through a carry trade strategy, which involves borrowing in U.S. dollars and investing in lira. This strategy has gained traction as investors show confidence in Turkey's efforts to curb inflation and revert to more conventional economic policies.

Bank of America strategists, including Mikhail Liluashvili, have recommended buying lira forwards, citing higher summer tourism revenues as a boost to the country's finances. "We are long TRY due to high carry, positive current account seasonality, and tight monetary conditions," they stated in a report. The lira has been the best-performing carry trade in emerging markets over the past six months, with a gain of 13%, according to data compiled by Bloomberg.

However, the strategists also cautioned about the risks of crowding in the lira, which could be problematic if there is an unexpected market shock. For some investors, Turkish government bonds may present a more attractive option.

Foreign Investment Surge

Foreign investors have significantly increased their purchases of lira-denominated Turkish government bonds, marking the largest monthly inflow into the country's domestic debt on record. Overseas investors bought a net $1.3 billion of the debt in the week through May 17, extending inflows over the past four weeks to $5.5 billion, according to the latest central bank data. This has brought non-residents' holdings of domestic debt to the highest level since February 2021.

The surge in foreign investment is attributed to pledges of monetary orthodoxy and lower inflation, which have bolstered investor confidence. The central bank's larger-than-expected interest-rate hike at its March meeting further encouraged foreign investors. A policy shift following last year's elections, which saw President Recep Tayyip Erdogan appoint a more market-friendly team of economic officials led by former Wall Street banker Mehmet Simsek, has notably improved sentiment among foreign investors.

Market Metrics and Analyst Views

The USD/TRY exchange rate remained relatively stable at 32.2082 as of 10:51 am in Istanbul. The 5-year Credit Default Swap (CDS) was little changed at 264 basis points, while the Borsa Istanbul 100 Index rose by 0.3% to 10,931 points. The U.S. Treasury 10-year bond yield remained steady at 4.43%, and Brent crude was stable at $81.86 per barrel.

Citigroup Inc. strategists have also expressed optimism about Turkish assets, describing the market as being on the verge of "a renaissance moment." Analysts, including Luis Costa, noted that the performance of the lira and bonds will largely depend on the central bank's success in re-anchoring inflation expectations. "The amount of Turkish government debt in liras held by non-residents has more than tripled so far this year, to $8.2 billion as of the latest available data," they reported.

Street Views

• Mikhail Liluashvili, Bank of America (Bullish on Turkish lira):

  "We are long TRY due to high carry, positive current account seasonality and tight monetary conditions."

• Luis Costa, Citigroup (Cautiously Optimistic on Turkish assets):

  "Turkish assets are on the verge of a renaissance moment. The performance of the lira and bonds will be shaped mainly by central bank’s success in re-anchoring inflation expectations."