Turkey Referendum: Everything You Need To Know About This Weekend’s Biggest Geopolitical Event

So, one thing you should note about “voting” in Turkey is that it isn’t really “voting” in that way where “voting” means you’re participating in a collective effort to dictate an outcome.

The only one “dictating” anything is President Tayyip Erdogan.

Remember what happened in June, 2105? No? Well let me briefly remind you.

See Erdogan’s AK Party came up short for the first time when it came to winning an outright majority in a parliamentary election. Worse (for Erdogan), the pro-Kurdish HDP topped the 10% threshold to enter parliament. Also a first.

Well fuck that.

Or at least that’s how Erdogan felt about it…

So do you know what he did? Well, first he reignited Ankara’s long-simmering war with the PKK. Then he deliberately undermined the coalition building process so he could (gun to his head) call for a redo. Then he cracked down on the media. And then he (maybe) staged a series of horrific bombings. Thanks to his efforts to antagonize the Kurds and thanks to the presence of ISIS (with whom Erdogan has variously been accused of commiserating) it was impossible for anyone to sort out who was behind the violence, which conveniently left Erdogan free to pin it on whoever he wanted and then say “see, this is why we need a strong leader.”

And that gets back to why he needed a redo election in the first place. AKP needed 2/3 of the seats in parliament to make a constitutional change that would consolidate power in the Presidency or, in other words, in Erdogan.

“We will take our country to early elections,” Erdogan told reporters in Ankara, on August 21, 2015. “God willing, on Nov. 1, Turkey will go through what I like to call repeat elections.”

Yes, “God willing” Turkey would have what Erdogan “likes to call” a “repeat.”

Or, in other words: “I’m going to give everyone one more chance to vote AKP before I start killing people.”

Well, one redo election, one failed military coup, and one truly epic purge later, and here we are – one day away from the referendum that Erodgan has been working towards. Here’s Reuters:

President Tayyip Erdogan appealed for support from Turkish voters in final campaign rallies on Saturday, the eve of a referendum which could tighten his grip over a country bridging the European Union and a conflict-strewn Middle East.

Opinion polls have given a narrow lead for a “Yes” vote in Sunday’s referendum to replace Turkey’s parliamentary democracy with an all-powerful presidency, a move Erdogan says is needed to confront the security and political challenges Turkey faces.

Opponents say it is a step towards greater authoritarianism in a country where 40,000 people were arrested and 120,000 sacked or suspended from their jobs in a crackdown following a failed coup attempt against Erdogan last July.

Western countries have criticized that tough response, and relations with the EU – which Turkey has been negotiating to join for a decade – hit a low during the campaign when Erdogan accused European leaders of acting like Nazis for banning referendum rallies in their countries on security grounds.

He has also said Turkey could review a deal under which it limits the flow of migrants – many of them refugees fleeing war in neighboring Syria and Iraq – into the European Union unless the bloc implements plans to grant Turks visa-free travel.

At a rally in Istanbul, one of four he held in the last hours before Sunday’s vote, Erdogan described the constitutional proposals as the biggest change in Turkey since the country was established nearly a century ago, and the culmination of the response to July’s abortive putsch.

“Sunday will be a turning point in the fight against terrorist organizations. We will finish what we started on July 15 this April 16,” he told a crowd in Istanbul’s Tuzla district, decked with Turkish flags and giant pictures of the president.

Erdogan’s Islamist-rooted AK Party has enjoyed a disproportionate share of media coverage in the buildup to the vote, but the result may be close. A narrow majority of Turks will vote “Yes”, two opinion polls suggested on Thursday, putting his support at only a little over 51 percent.

“Tomorrow is very important, you must absolutely go to the polls,” Erdogan urged the crowd. “Don’t forget that the vote is our honor.”

Right. “Don’t forget that the vote is our honor.” Or, translated, “don’t forget that if you vote ‘no’ there’s going to be all kinds of trouble.”

For markets (and especially for EM), this is obviously a big event. Here’s SocGen’s quick take:

The Turkish constitutional referendum ought to be next week’s most important event for emerging markets. The most recent polls have the ‘Yes’ camp winning by 2-3%, but with 6% undecided the result could go either way. The vote itself is not the end of the matter; while a ‘No’ vote seems likely to lead to near term elections, a ‘Yes’ might also do so if President Erdogan looks to cement his leadership.

The impact on the markets looks binary. A ‘Yes’ vote would likely see TRY strengthen, while a ‘No’ vote could see it underperform the rest of the EM FX complex. However, we have recently taken the TRY out of our FX high yielding basket, given the uncertainty on both the outcome of the referendum, and how policy will evolve in its aftermath. The local government curve has translated upwards and flattened sharply, with the front end rising the most as the CBRT keeps a tight stance via the average cost of funding. Receiving short rates has better risk-reward than paying, and if the currency stays well behaved the CBRT might be inclined to incrementally ease funding post-referendum. A major beneficiary of a ‘Yes’ vote would be hard currency bonds: although USD Turkish bonds have outperformed local assets (as we noted last week), we think there is more to go and Turkey remains the biggest overweight position in our hard currency portfolio.

And here’s Barclays:

Turkey is heading for a public referendum on the presidential system on 16 April, this Sunday. The recent polls suggest a pick-up in momentum in favor of “yes” (Figure 1) and this is also evident in the latest surveys of pollsters such as Metropoll and Gezici, which show “yes” at around 53% as opposed to earlier surveys of below 50%. The “yes” and “no” outcomes still appear to be close on average, however, and the associated margin of error (2-3% according to pollsters) along with the large share of “undecided” voters underscores the binary nature of the referendum outcome.

Achieving 50%+ support for the “yes” campaign (AKP-MHP) might look relatively straightforward at first sight, given a combined voter base of 61% (November 2015 election results) and the almost perfectly aligned rhetoric and policies of the parties. Recall that the transformation of the political landscape before and in the aftermath of the November 2015 elections led to a firm macro-level consolidation of Turkish politics along two lines: the “nationalist front” (mostly AKP and MHP voters) and the “social democrat front” (mostly CHP and HDP voters). However, polls suggest a less comfortable race for the “yes” campaign: i) a large number of MHP voters seem to still be unconvinced by the “yes” campaign, and ii) the true color of the “undecided voters” is hard to decipher: pollsters say voters are increasingly refraining from revealing their preference due to the mood created by the extraordinary state of affairs, and “undecided” voters could be skewed towards “no”. Metropoll argued that more than 75% of undecided need to vote “no” for it to win; while historically, undecided voters have tended to either vote for the status quo or not participate in elections. The low polling response rate due various factors (such as peer pressure in the South East and the Black Sea regions according to some pollsters) is yet another complication that could potentially be distorting the poll results.

Nevertheless, momentum has picked up in favor of “yes” based on the most recent polls, and this has also been echoed by the political expert media commentary. Among the key catalysts, experts note the following. (1) The effectiveness of President Erdogan’s campaign to push the “yes” votes of the AKP electorate higher (from the 80% level to the 90% level), as well as its impact on convincing more of the MHP electorate to vote “yes”. (2) The tailwind provided by escalating tensions with the Netherlands and the EU, which is likely to help consolidate the nationalist vote. (3) The positive impact of the improving economic sentiment recently on the “yes” campaign. (4) The tactical missteps of the main opposition party CHP (i.e. comments by party officials) influencing undecided AKP voters in favor of “yes”.

The market appears largely positioned for an outcome consistent with polls that suggest a “yes” result is most likely. In FX option markets, for example, the volatility-adjusted premium for USDTRY calls versus puts has recently dropped to multi-year lows and below-average kurtosis suggests little demand for negative tail-event protection (Figure 4). In bonds, TurkGB risk premia remain extremely low and currently offer less return than USTs on a hedged basis (Figure 5). Finally, in EM credit, Turkey YTD has outperformed the broader Bloomberg Barclays USD EM sovereign index, partially reversing the c.10% underperformance in 2016 (in total return terms).

YES: A “yes” outcome would likely result in a broad-based, yet potentially short-lived, relief rally

Despite the market’s anticipation of a “yes” outcome, we think the associated reduction in near-term political uncertainty would likely still deliver some relief rally,allowing a temporary reprieve for the TRY and a steeper curve in anticipation of a “gradual” unwinding of tight liquidity policy.

In FX, still-large TRY political risk premia and undervaluation suggest room for appreciation following a “yes” outcome. While our estimate of the lira’s political risk premia has reduced from 15pp at the end of January, it remains relatively large at 8pp (Figure 6). Furthermore, our short-term Financial Fair Value (FFV) model suggests a 4% undervalued TRY against the USD (Figure 7). We believe risk-reward argues for being long TRYZAR targeting January highs of 3.90 with a stop-loss at 3.67 for a reward to risk ratio of 3:1 (spot reference: 3.73). We prefer this to short USDTRY as South Africa’s similarly low risk-adjusted real interest rate differentials and heightened political risk should provide a degree of protection in the event of a “no” outcome (Figure 8). The trade also remains positive carry.

In rates, very low bond risk premia suggest a rates rally following a “yes” is likely to be concentrated at the front end of the yield curve as market participants will likely price a gradual unwinding of the CBT’s liquidity tightening measures. As such, we reiterate our existing trade recommendation of paying the 1s5s TRY cross-currency swap spread targeting -30bp with a stop-loss of -100bp (3m annualized carry and roll: -2bp.

For Turkey sovereign credit,we maintain our Market Weight rating. This balances our concerns about a likely medium-term deterioration of Turkey’s credit metrics in a presidential system on the one hand with relatively attractive valuations and likely reduced near-term political uncertainty in a “yes” vote on the other hand. In the near term, we see potential for further spread compression of Turkey against South Africa, especially in the 5y sector of the curve (Turkey ‘22s vs SOAF ‘22s), with South Africa remaining vulnerable to adverse developments, in our view.

In the corporate credit space, we also have a Market Weight rating on Turkish banks and corporates. In the case of a “yes” vote, we would expect bank seniors to benefit more than corporates given the more significant spread pick-up relative to the sovereign. Higher beta seniors trading at a discount of over 100bp to the sovereign as well as new-style Tier 2s yielding over 7% are likely best positioned to benefit, in our opinion, although this could be met with more Tier 2 supply. We would expect the opposite reaction to a “no” vote, with IG-rated corporates and more expensive bank seniors as well as old-style Tier 2s to be less vulnerable in any sell-off.

NO: Positioning for a “no” outcome looks most compelling via FX options

The less-expected “no” outcome will likely result in larger market movements as a higher risk of an early election would increase risk premia in the local bond curve, weigh on the lira and increase FX implied volatility, in our view. We think FX options are the most attractive instrument for investors to express expectations of a “no”. While the greatest exposure to a pickup in near-term TRY volatility comes through straddle and strangle option structures, these are very expensive. We suggest two cheaper alternative examples that still benefit from a potential pickup in volatility over the next month:

·      Long volatility without a directional view — USDTRY butterfly: For those investors looking to benefit from a pickup in volatility over the next month but who do not have a strong directional view, USDTRY option butterfly structures may be attractive. An example with a 1-month tenor is to buy a 25-delta USDTRY put (strike: 3.5717), along with a 25-delta USDTRY call (strike: 3.8485), partly financed by an ATM-forward USDTRY call (strike: 3.6968) with half the notional value. The indicative cost of this structure is about 85bp.

·      Long volatility and short TRY — USDTRY call: For those investors with a view that USDTRY volatility is likely to increase and USDTRY will appreciate over the next month, buying a 1-month 25d USDTRY call (strike: 3.8618) costs about 100bp (spot reference: 3.6802). We would recommend selling the call prior to expiry following events that result in higher implied volatility, such as a potential announcement of an early election. Alternatively, if it is held to maturity, the cost of the option is covered above 3.90 USDTRY. An aggressive version of this view would be to buy the USDTRY risk reversal (buy the call, sell the put) but the associated risk of unlimited downside materially reduces its attractiveness.

In rates, our existing trade recommendation of paying the 1s5s TRY cross-currency swap spread should be protected in the case of a “no” as greater political risk premia support 5-year yields, helping to offset upward pressure on 1-year yields from increased CBT tightening expectations.

Got all that?

At the end of the day, this has all manner of implications for:

• the EU, as Turkey is the corridor through which Mideast refugees fleeing violence pass
• the US, as Washington flies from Incirlik when conducting bombing runs in Syria
• NATO (for obvious reasons)
• emerging market assets (again for obvious reasons)

Finally, do note that should things not go Erdogan’s way, don’t expect him to simply accept an adverse outcome…

Via Bloomberg (note the infamous “Gulen” excuse makes a cameo)

• If ‘No’ Wins Referendum, May Need to Hold Another: Erdogan Aide
• If Turkish people reject proposal to change the constitution at Sunday’s referendum, another referendum could be held, Mehmet Ucum, adviser to President Recep Tayyip Erdogan, said in an interview with Bloomberg in Ankara.
• “I don’t think the proposed model is lacking, but if there are things determined to be lacking, it might be necessary for us to address them and then go before the people again. A new referendum could also be discussed. But no one can say on April 17: ‘the current system is good, let’s continue with this’”
• Says only parliament could move elections forward; “the parliament, which has been given its authority by the people, has the right to make an independent decision to call early elections”; ‘‘early elections could happen in case of a ‘yes’ or a ‘no.’”
• Says state of emergency imposed after July 15 coup is still necessary for the fight against terrorism, and could be extended
• “France’s state of emergency has been imposed more than 2 years, and elections for both legislators and the president were carried out under the state of emergency”
• “The threat for us is much bigger than for France. We also need instruments under the state of emergency to solve some problems that have emerged in the fight against FETO,” or the Fethullah Gulen movement. “So my expectation is that until these needs are met, it’ll continue”
• “If ‘yes’ wins, a reform process will start. For example, the age for all elected positions will be reduced to 18. Because the 10 percent threshold will be meaningless, reform of the election system will come to the agenda. Changes to political party and election laws will also come to the agenda”
• “There’s no place for a state system in a unitary state structure. You can’t establish politically autonomous administrations with decrees or with laws”
• “I think a strong ‘yes’ is going to win, but ‘no’ is also valid”
• Erdogan could become a member of AK Party should ‘yes’ win, but would not have to be its leader