Vote in Turkey’s less risky than the market thinks

The implied volatility of emerging market currencies during the past six months has tracked world market conditions. The main macro determinant of volatility in the whole EM currency complex is American monetary policy.

As rates peaked at the end of 2022, so did emerging markets’ currency volatility, and volatility fell with US bond yields during 2023 – with the exception of Turkey. Hedging in the advent of the country’s May 14 presidential election has pushed the implied volatility of short-term options above 40% and the interest rate on overnight deposits to above 80%, as the central bank squeezes the money market to discourage shorts.

Noteworthy is that the cost of default protection against the Turkish sovereign hasn’t moved while the cost of hedging the Turkish currency has jumped.

We think concerns about Turkey are overdone. In fact, Turkish policy has very little room to change. Financially, Turkey is dependent on the Gulf States and China. A great deal of attention was focused on China’s role in mediating the restoration of diplomatic relations between Saudi Arabia and Iran. But Turkey was a de facto partner to this agreement, in several ways. Turkey’s role in containing the long-simmering civil war in Syria is central.

On April 25, Turkey, Russia, Iran and Syria held “constructive” talks. Turkey has been the main sponsor of anti-government Sunni rebels during the past dozen years, and the main bulwark against Shia militias supported by Iran.

Turkey’s role in containing Iran’s expansionist ambitions is an implicit feature of the Iran-Saudi agreement. It follows a year of rapprochement between Turkey and the Gulf States, and establishes Turkey’s role as an economically dependent but militarily dominant force in Western Asia.

Turkey’s economic relationship with China is the cement that holds this together. China’s exports to Turkey have tripled since 2019. Some part of the increase reflects indirect exports to Russia. Turkey has emerged as a key economic intermediary between Russia and the rest of the world, including electronic equipment from China and Russian hydrocarbons shipped via Turkish pipelines.

We expect Erdogan to win the election given the blandness of his main opponent, an elderly retired civil servant heading a coalition of six mutually antagonist parties. But whoever wins will have to stay in the groove that China, the Gulf States and Russia have carved out for Turkey.

Rather than become a hegemonic neo-Ottoman Empire, as Erdogan once hoped, Turkey is settling into a role as the most powerful nation-state in Western Asia. It is well suited for this and unlikely to deviate from the course that Erdogan has charted for the past two years.