(Bloomberg) — As the Turkish lira took its sharpest nosedive in four years, Pavel Mamai saw the opportunity he’d been waiting for.
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“When the lira’s losses hit 10% yesterday, we thought this could be what we like to call the ‘pod moment,’” when multi-strategy funds are forced to sell, said Mamai, the co-founder and managing partner of Promeritum Investment Management, a hedge fund focused on emerging markets.
The sudden lira slump triggered by the early-morning detention of popular Istanbul mayor Ekrem Imamoglu on Wednesday meant big foreign funds had to rapidly reduce their exposure. That sent returns on the so-called carry trade in Turkey from one of the highest in emerging markets this year to a loss. In carry trades, investors borrow in currencies where rates are low and invest in high-yielding countries.
As the foreigners sold, Mamai moved in to buy lira assets, correctly wagering that the turbulence would guarantee central bank support and keep interest rates high — factors that had underpinned the more than 5% carry-trade return up until Wednesday.
The crackdown on a potential challenger to President Recep Tayyip Erdogan was a sharp reminder of the country’s political risks. Local banks were forced to sell about $8 billion to stop the worst currency retreat since 2021 and the central bank hoisted its overnight lending rate 200 basis points to 46% at a surprise meeting Thursday.
“The danger for the central bank is not foreign investors,” said Mamai, who manages $650 million from London. “They’ve got more than enough reserves to let all foreign investors out, the danger is with the locals.”
Markets were showing signs of stabilizing on Thursday, with the currency trading little changed at around 37.90 per dollar as of 8:55 p.m. in Istanbul, hours after the overnight rate increase. Banks including HSBC Holdings Plc warned there’s a risk of more selling over the rest of the year.
According to estimates by Bloomberg Economics’ Selva Bahar Baziki, the central bank should “comfortably accommodate” any hot-money outflows. The Turkish Central Bank had more than $50 billion of net reserves at the end of February, about double the amount of funds foreign investors brought in to profit from the carry trade, she said.
“The main risk is a spillover of sentiment from foreign investors to domestic savers,” Bahar Baziki said. If that happens it would put an additional burden on central bank reserves and the cash pile would be sufficient to keep a lid on inflation for up to three months, she said.
Turkish Banks Said to Have Sold Around $8 Billion to Defend Lira
Imamoglu’s detention was a reminder to investors that Erdogan is prepared to sacrifice market stability to achieve his political goals, said Ulrich Leuchtmann, head of FX research at Commerzbank in Frankfurt.
“That justifies a higher risk premium,” he said.
In the past, Erdogan insisted on keeping interest rates low, contributing to a spiraling inflation rate and frequent currency-market meltdowns. The share of foreign investors in the local bond markets was below 1% in 2023 and MSCI Inc. warned it may be forced to strip the nation’s stocks of their emerging-market status.
With the nation’s foreign exchange reserves well below zero, Erdogan reversed course that year — appointing the investor-friendly Mehmet Simsek as finance minister and unleashing a series of aggressive interest-rate hikes that took the key rate as high as 50% to stabilize the markets.
In July, Deutsche Bank hailed the central bank’s “strong commitment” to orthodox policies. Hedge funds made bullish calls touting the nation’s monetary policy shift as one of the best trades among developing nations.
Turbulence Returns
That relative calm appeared to end on Wednesday morning with Imamoglu’s detention. Now, investors are watching to see if the political tensions escalate and hoping it remains an isolated event that doesn’t dent the government’s economic trajectory.
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“My sense is that the economic policy orthodoxy will likely remain in place,” said Carlos de Sousa, emerging-market debt portfolio manager at Vontobel Asset Management. Still, “if the recent developments result in large protests, and re-dollarization, then it would be much harder for the current policy framework to succeed,” he said.
For now, Promeritum’s Mamai is happy to increase lira exposure amid the knee-jerk moves.
“It’s always volatile in emerging markets,” he said. “The financial markets implications are such that the logic for the carry trade, the real appreciation of Turkish lira over time has probably been even strengthened.”
(Updates time for lira exchange rate. A previous version was corrected to remove a currency chart.)
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