Turkey expands financial firepower

Published: May 4, 2017

Turkey finally got dropped into junk status by the third of the major ratings agencies at the end of January, but this potentially devastating development for the sovereign was so long expected that there is a growing belief that the only way is up from here for the country.

Fitch Ratings cut the Turkish sovereign rating from BBB- to BB+ on January 27, following similar moves from Moody’s and an unsolicited Standard & Poor’s, with the rocky political situation in the country cited as Fitch’s driving factor following a failed coup in the summer of 2016.

“The failed coup attempt in July 2016 has been a critical turning point,” Erkin Isik, a strategist at Turk Ekonomi Bankasi, BNP Paribas’ Turkish partner, told EMEA Finance, “which was followed by rating downgrades to non-investment grade and this led credit spreads to widen.”

While spreads widened, the downgrade might not be as big a condemnation for Turkey as it could have been, as the move was largely expected by markets and investors had already adjusted their Turkish holdings accordingly. 

“The rating downgrade was already very much priced in,” Cecile Camilli, head of debt capital markets for CEEMEA at Societe Generale, told EMEA Finance. “If you look at how the markets reacted, it was actually quite positive.”

Credit default swaps on Turkish five-year sovereign debt was flat on the day of the downgrade at 270bp, and had tightened to 260bp by early February. 

In the immediate aftermath of the downgrade, the sovereign’s due 2027 bonds shot up by two-thirds of a point to 101.179, a bond trader who could not be named as they are not permitted to speak to the press told EMEA Finance. They moved tighter in Z-spread terms, too, ratcheting in up to 10bp tighter on intra-day trading.

“This mood brings a classic ‘sell the rumour, buy the fact’ trade in Turkey,” said a second trader via email. “Fitch downgrades them to junk late Friday, but Turkish lira and all the sovereign and bank paper much firmer [on the Monday]...one point higher in the long end.”

This poses something of a conundrum for bond investors, as while Turkish debt is performing well, the fundamentals that have seen it rated junk by all three agencies are still a major concern.

“In many respects there are good reasons to be cautious,” said Tim Ash, senior sovereign strategist at BlueBay Asset Management.

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