Goldman Says Turkey Is ‘Back in the Game’ With Lira Carry Trade

The lira carry trade is back as Turkey ramps up its campaign to bring inflation to heel, according to Goldman Sachs Group Inc.

(Bloomberg) — The lira carry trade is back as Turkey ramps up its campaign to bring inflation to heel, according to Goldman Sachs Group Inc.

Strategists at the Wall Street bank expect interest rates, when adjusted for the future inflationary outlook, to turn positive in coming months as policymakers pull harder on the monetary levers to tamp down on price pressures. Real rates currently stand at minus 29%, one of the lowest levels anywhere in the world.

If the central bank hikes its benchmark rate to 40% or higher by year-end, that would surpass Goldman’s inflation forecast for the next 12 months. Such a trend would help to put the lira carry trade — in which investors borrow money in countries with low interest rates to earn higher returns by parking it in Turkey — “back in the fray,” strategists including Kamakshya Trivedi and Caesar Maasry wrote in a report.

They’re making their call just days after Goldman co-hosted an investment conference in New York where Turkish Finance Minister Mehmet Simsek sought to woo money managers skeptical of President Recep Tayyip Erdogan’s embrace of more conventional policies since winning reelection in May.

The return of carry-trade investors would represent a stark shift for Turkey, after a long stretch when the central bank kept rates deeply negative while leaning on financial regulations to drive up demand for local assets and make it expensive to short the lira during a time of crisis.

The lira has weakened 32% this year to trade at 27.4 per dollar on Thursday, racking up the biggest losses among the currencies of developing nations after the Argentine peso. In another sign of investor skittishness, Turkey’s lira bonds have lost about 16% this month, the worst performer across emerging markets, according to data compiled by Bloomberg.

Official Support

Goldman expects Turkey’s currency to trade at 28 and 29 against the dollar in three and six months, respectively, stronger than the levels in the forward markets, the strategists said. The new official support for “a positive real rate strategy” suggests that “it may be possible to beat the FX depreciation reflected in forward pricing again,” they wrote.

Since Erdogan appointed Hafize Gaye Erkan, who once worked at Goldman, to helm the central bank in June, the monetary authority has more than tripled its key rate to 30%, including a 500 basis-point hike this month. 

“With this more front-loaded and forceful rate adjustment, near-term pressures on the currency have eased,” the strategists wrote in a report. “That should allow the lira to continue to outperform near-dated forwards during this period.”

Turkey’s local debt market — once a big draw for foreign investors  — has all but fallen off their radar, with non-resident holdings now at just over $1 billion compared with the peak of more than $60 billion reached a decade earlier.

Conventional Policy

Even so, Turkish dollar debt has been quicker than the currency market in pricing in a return to more conventional policy, the strategists said. The nation’s risk premium over US Treasuries is now lower than JPMorgan Chase & Co.’s benchmark emerging-market bond index, with the difference at its greatest level since 2016.

That gives scope for investors to pair a carry-trade strategy with “inexpensive credit hedges,” they said, noting that local and international flows have supported the debt rally.

Meanwhile, Turkey will probably sell about $7.5 billion of bonds for the rest of 2023, after issuing a similar amount so far this year, according to Goldman.

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