The Daily Update - Turkey Junkey

As was widely expected, rating agency Moody’s downgraded Turkey’s Baa3 long-term rating by one notch to junk, Ba1. Moody’s cited 'The increase in the risks related to the country’s sizeable external funding requirements' and 'the weakening in previously supportive credit fundamentals particularly growth and institutional strength' as the main drivers for the downgrade. A report from Moody's also highlighted the country’s susceptibility to event risk as ‘high’ adding its concerns over the country’s vulnerability to political instability and geopolitical risks emanating from ‘Syria’s ongoing civil war and the crisis in Iraq.’ After the failed coup in July, Standard and Poor’s swiftly downgraded the country’s rating to BB, however Moody's said it would take time to review the situation later stating, ‘The risk of a sudden disruptive reversal on foreign capital flows, a more rapid fall in reserves and, in a worst-case scenario, a balance of payments crisis has increased”. Fitch is the only major rating agency to maintain an investment grade rating on the country; at BBB-.

Although a very popular holding amongst emerging market indices, we have never held Turkish debt, the main reason being that the country has a Stratton Street NFA score of only 2 stars; thus not within our investable universe. Also using our Relative Value Model, we calculate that the benchmark government curve is already pricing in a number of downgrades and is therefore trading fairly close to fair value, with the most attractive point of the curve at 5-years. The 5.625% 2026 offers a small 2.5% expected return and only 1.5 notches of credit cushion; we would much rather invest in 7 star, Aa2/AA rated sovereign paper like Qatar 9.75% 2030s which offers an expected return of around 11%, and has 5.5 notches of protection.

Overnight all eyes were on the US presidential debate, with markets once again showing their knee-jerk reactions; rallying on the back of a close 1:0 win to Clinton. Emerging market (particularly commodity dependant) currencies and bonds have enjoyed a nice bounce while safe haven assets retreated; gold fell and the yen weakened. It is very evident that a Clinton win is supportive for markets and the idea of Trump in the White House will create a risk-off environment. The Mexican peso was a clear winner yesterday having gained ~1.5% from all-time lows while the yield on the 10-year US Treasury fell below 1.6%. We look to the next two debates on the 9th and 19th for any further clues. In the meantime, we continue to hold a blend of highly rated bonds and attractive beta positions; creating single A portfolios yielding 3.5-4%.

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