Thursday, February 18, 2010

CEEMEA Rates Trade Idea Pay 5y Turkish CCS

Rationale: The TRY 5y CCS seems to be trading at the bottom of the range (10-10.80). Given our economists’
view that CPI inflation will climb higher this year before starting to fall in 4Q10 (Exhibit 1), the risk/reward of
tactically paying rates in Turkey looks attractive to us.

While we acknowledge that the curve is already quite steep, we do not think that sufficient rate hikes are priced in at the moment. Based on our estimates, the curve is pricing in around 250bp of hikes by end-2011,
compared with Morgan Stanley’s forecast of 325bp.

Real yields are also reaching a turning point. Given the historically strong relationship between real GDP and real yields, we think that real yields are close to the
bottom and should turn around soon, following the trend in real GDP. Even as inflation starts to fall after 4Q10, we think that nominal yields should continue to rise, given our economists’ GDP forecast of 4%Y at end-2010 and 4.2%Y at end-2011.

Oil and food also pose upside risks to our inflation
forecast, in our view. Furthermore, the longer the CBT
keeps rates on hold, the higher the likelihood that
inflation expectation might deteriorate further, thus
mitigating some of the (positive) base effects from 4Q10.
Carry/rolldown: Over a 1-month period, the
carry/rolldown on a pay 5y CCS position is around -9bp.
This compares more favourably with -20bp in 2y and
-22bp in 1y.

Alternatives: We still like paying breakeven inflation by
holding 2y linkers versus paying 2y CCS.
Key risks: Persistent lira strength, a significant
improvement in inflation profile (e.g., lower oil or food
prices), a potential IMF package and a lower domestic
debt rollover ratio in March and April could put
downward pressure o
n rates, in our view.

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