(Bloomberg) -- BNY is warning that the influx of foreign capital into Turkish assets may be overdone, with investors likely ignoring pitfalls that could prompt a reversal.
Overseas investors have poured billions of dollars into Turkish assets this year, many banking on the currency appreciating. However, sky-high borrowing costs and geopolitical tensions pose substantial threats to this crowded currency trade, according to Bob Savage, the bank’s head of markets and strategy.
“Turkey is at the crossroads of a mess,” Savage said in an interview in Hong Kong. “You could see the Iranian-Israeli conflict getting worse. You could see the Russia-Ukraine conflict getting worse. And Iran being part of that story and Turkey being caught in the middle.”
Turkish President Recep Tayyip Erdogan escalated his rhetoric against Israel on Sunday, underscoring the growing hostility and potential impact on the nation’s financial assets. Despite this, a combination of high interest rates and hopes that the central bank will remain committed to fighting inflation has attracted global money back this year.
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Turkey’s central bank extended its interest-rate pause for a fourth month last week, leaving its benchmark one-week repo rate at 50%. This decision followed Moody’s upgrade of Turkey’s credit rating by two notches, the first increase in 11 years.
“I’m not sure that it can sustain 50% interest rates,” Savage said. “People are long bonds, they’re long equities and they’re long the currency. It’s a trifecta.”
Bank of America strategists have calculated that positioning in Turkish lira forwards could now exceed $20 billion. Deutsche Bank, which called Turkey the “trade of 2024”, and Pictet Asset Management are among those bullish on Turkish debt and currency.
Foreign holdings of local debt have climbed to more than $12 billion from less than $1 billion a year ago, according to data compiled by Bloomberg. State-run banks have helped to steady lira’s depreciation to below the monthly inflation rate, allowing the currency to appreciate more than 11% in real terms this year.
Savage said that a reversal could occur in the fourth quarter or early next year, with inflows rotating to “counterweight” frontier economies like Egypt, Nigeria and Argentina.
“People are happy with the policies and it is on the right path, but I’m not sure that it deserves all the money,” Savage said. “Recognizing that there are problems that will make it unwind. That’s real.”
--With assistance from Kerim Karakaya.
(Adds lira performance data in eighth paragraph. A previous version corrected the firm’s name in headline, first paragraph to reflect BNY’s rebranding)
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