Turkey Lira Crisis Eases Treasury Yields Into Key Bond Auction Week

The Treasury will auction nearly $330 billion in bills and bond this week and may get help from foreign buyers looking to avoid the fallout from Turkey's Lira crisis.
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U.S. Treasury yields ticked lower Monday, providing early support for tech stocks that could extend throughout the week as the government looks to unload nearly $330 billion in new debt onto a cautious and unsteady bond market.

Turkey President Recep Tayyip Erdogan fired the country's central bank chief, Naci Agba, over the weekend, just days after he had approved an 200 basis point interest rate hike designed to blunt the impact of inflation in the struggling economy. 

"The new political interference from Erdogan, who has long railed against hiking interest rates because he thinks they cause inflation, send the lira into a tailspin on fears that international investors will pull their money from the country on concerns of new rate cuts the would undermine the orthodox “'bitter medicine' of further interest rate hikes to stabilize and strengthen the currency," said Saxo Bank strategists. "The country is already low on reserves and could, in extremis have to implement capital controls if capital flight, whether domestic or foreign, becomes a deepening problem."

The move sent the Turkish lira down 15% against the U.S. dollar, the steepest decline in nearly three years, and triggered a rush to safe-have assets in Europe and elsewhere, including U.S. Treasury bonds, with benchmark 10-year notes falling to 1.68% from the 1.75% peak, the highest since January 2020, they reached during the height of last -week's sell off.

Ironically, much of what Governor Agba said with respect to rate hikes -- which he linked to shift in global investor appetite, loose central bank policies around the world, rising commodity prices and near-term inflation risks -- are concerns that have triggered the longest rise in U.S. Treasury bond yields in eight years and corresponding pullback in tech and growth stocks.

Further upward pressure followed last week when the Federal Reserve, fresh off its March policy meeting that pledge to keep rates at record lows for at least the next two years -- even as the economy looks set to grow at its fastest pace since 1984 -- ended a capital break for domestic banks that could lead to further Treasury bond sales, and thus higher yields, in the months ahead.

Normally, that would have investors exceedingly nervous heading into a hectic week of bond auctions, which includes a $60 billion sale of benchmark 2-year notes on Tuesday and another $62 billion in 7-year notes on Thursday, as inflation signals hot up and deficit hawks renew their criticisms of the Biden Administration's $1.9 trillion American Rescue Act.

Turkey's brewing currency crisis, however, alongside the sputtering vaccine rollout efforts in Europe that are likely to delay the region's post-pandemic re-opening, are likely to boost demand from international investors for the U.S. assets on sale this week, keeping prices high and borrowing costs low.

A $38 billion sale of benchmark 10-year notes earlier this month, in fact, drew solid international demand, with foreign investors taking up 57% of the overall total. 

That said, analysts at JPMorgan caution that the Fed's removal of the SLR benefit, just as primary dealers are likely needed to take-up a greater share of the $209 billion in coupon paper on sale this week, could lead to another leg higher in Treasury yields -- and corresponding pressures on U.S. stocks -- in the days ahead.

"While valuations are supportive of increased demand from foreign investors ... foreign demand alone is unlikely to stabilize Treasury yields," JPMorgan said. "Moreover, over the very near term, liquidity conditions lend upside risk to yields ahead of (this) week’s supply process."