Turkey and IMF End Aid Talks

In a long engagement, Turkey and the IMF have been negotiating a stand-by package for well over a year. Today Turkey announced that there would be no marriage afterall--no deal. The impasse appeared to be over municipal expenditures. PM Erodogan's government had previously negotiated two programs with the IMF since coming to power in 2002.

There is disappointment in some quarter of the end of the protracted talks as some suggest the talks themselves had lent support to the lira and the bond market. As noted yesterday, the poor inflation news at the end of last week, coupled with the heightened political anxiety and withholding tax uncertainty have weighed on Turkish bonds. Yields yesterday rose to their highest for the year amid a lukewarm reception to the bond auction and there is follow through selling today.

Turkey does not have a long-term bond. It's benchmark 2-year bond yield is at 9.52%, up 6 bp today. For the year to date, the yield has risen 33 bp, the same as Portugal's 2-year bond and well behind Greece's 133 bp increase this year. Portugal's 2-year yield remains a lowly 1.75%.

The euro has fallen about 2.5% against the lira year-to-date and currently is trading near TRY2.092. Buying 2-year Turkish bond and selling the 2-year Portugal bond bond against it picks up 775 bp annualized. The risk of course on such a trade is that the euro rises against the lira. A roughly 5.5% euro rise would bring it to the 61.8% retracement of the decline recorded since late November (~TRY2.2150). More immediately, the TRY2.12 area may cap euro uptick.

Our correlation work suggests that euro-dollar and euro-lira are not tightly related. The correlation (conducted at on the basis of percent changes)was about 33% last year and has eased to about 25% this year. That said, our bearish outlook for the euro may limit the euro's ability to rise against the the lira, making the "buy Turkish 2-year against Portugal 2-year" an interesting trade idea for some medium term investors.