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Hedge funds and other traders have pumped billions of dollars into the Turkish lira in recent months in search of big profits, but investors and analysts say the influx of “fast money” has made Turkey more vulnerable to sudden swings in sentiment.
Asset managers have poured about $24 billion into deals since October seeking to profit from Turkey’s high interest rates, currently at 50 percent, according to Istanbul-based Burmcekci Research and Consultancy.
To maximize profits, managers borrow funds for transactions in the currency with the lower interest rate, hoping that the exchange rate will not move adversely in the meantime.
The surge in the lira is the latest sign that Turkey’s shift toward more conventional economic policies, which began last summer, is helping to lure back international fund managers who fled the market in recent years as unorthodox policies fueled runaway inflation.
“The lira has become a very hot trade,” said Grant Webster, co-head of emerging markets sovereign debt and foreign exchange at investment management firm NinetyOne.
“Turkey is experiencing large foreign inflows as a result of its shift away from high interest rates and unorthodox economic policies,” he added.
Investors are holding the Turkish lira to its highest level in nearly five years, outstripping the benchmark index’s weighting, according to a June survey of JPMorgan clients.
Most of the inflows have come in the form of “fast money” inflows – hedge funds and other investors who can exit quickly in the event of a domestic or international shock, analysts and investors say.
“The proportion of fast money in these trades is increasing and it certainly makes them more susceptible to reversals,” said Kieran Curtis, head of emerging markets local currency bond at fund manager Abledon.
That sentiment was echoed by a Turkish economic official, who spoke on condition of anonymity, saying the downside to a resurgence in the virus is that an external crisis, such as rising oil prices, could see fickle investors flood out of Turkey’s markets.
The inflows came after President Recep Tayyip Erdogan, who once called high interest rates the “root of all evil,” abandoned his insistence on keeping borrowing costs ultra-low after his re-election in May 2023.
Turkey’s central bank has raised its key interest rate to 50 percent from 8.5 percent since June last year as part of broader economic reforms.
Moody’s Investors Service on Friday gave Turkey an unprecedented two-notch upgrade in its junk credit rating to B1, saying a “return to monetary orthodoxy is becoming increasingly entrenched.”
The head of a large emerging markets hedge fund that has allocated significant capital to the carry trade added that at the moment “we’re looking at Turkey in a positive light.”[Erdoğan] “Turkey knows it has to get inflation under control,” he said, adding that “Turkish savers fled to the dollar but now they are coming back.”
Another hedge fund manager who trades lira carry said he was less concerned about foreign investors pulling out of the market than the risk of local savers losing confidence in the lira and moving their savings back into dollars or euros.
According to Bloomberg data, the Turkish lira has generated an 18% total return against the U.S. dollar, including interest income, in 2024 despite Turkey’s sharp depreciation. Few other emerging market currencies have offered such a high total return.
In addition to betting on the currency, foreign investors have bought up about $12.5 billion in lira-denominated government bonds since the economy took a sharp turn last June. Foreign investors now hold 6.7% of the country’s outstanding debt, according to finance ministry data, up from 0.6% before the general election in May.
These international inflows have been a major boon to the central bank’s efforts to rebuild foreign exchange reserves, which have been decimated in recent years by failed attempts to prop up the lira and rising imports due to strong demand for consumer goods.
Net external assets, a measure of foreign exchange reserves, jumped to $40 billion from around minus $20 billion last summer, according to Financial Times calculations based on central bank data.
Net assets exclude some of the central bank’s liabilities, but do not take into account short-term borrowings it has taken out from the domestic banking sector through swaps.
Webster said these rising reserves, along with the central bank’s stance of tightening monetary policy, would help Turkey prevent a surge in its currency in the future, adding that the central bank is currently “in a very strong position to prevent outflows.”
But many conservative investors, such as pension funds, remain nervous about putting significant amounts of money into Turkey, fearing that Erdogan will change policy as he has done many times in the past to suit political convenience.
Large-scale foreign direct investment in factories and other projects also remains elusive.
“[Finance minister Mehmet] “Symesek is likely to deliver the more predictable Turkey that FDI needs, but the rewards will not be seen for several years,” said Charlie Robertson, head of macro strategy at emerging markets specialist FIM Partners.
