Picture borrowing in Japan at near-zero rates, then parking the money in Turkey at 37%. That's the lira carry trade in a single sentence.
It's printed profits for almost three straight years. Now an oil shock is threatening to flip the math on its head.
A carry trade is simple. You borrow cheap in one country and earn high interest in another, and the difference is your profit, as long as the higher-yielding currency stays stable.
Turkey has been the global star of this trade for nearly three years.
Bank of America once called it one of the most attractive carry destinations in emerging markets, with returns near 10% a year, and the smart money piled in.
Carry positions in lira assets topped $60 billion this past January, according to estimates from Turkish economists.
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The war involving Iran sent oil prices sharply higher this spring. That hits Turkey harder than most countries because it imports nearly all its fuel.
Higher fuel prices push up the cost of almost everything else, from food to transport to manufacturing. Right when the central bank was trying to cool inflation, oil reset the clock.
Turkey's finance minister, Mehmet Simsek, has said the government is absorbing about 75% of the oil shock through fiscal measures.
The goal is to hold inflation in check long enough for the disinflation plan to keep working, but that's a tough balance when energy prices keep climbing.
Carry traders only make money if the lira holds its value, because a sharp fall would wipe out the interest-rate edge.
After conflict broke out in late February, investors pulled an estimated $12 billion out of Turkey in the first two weeks of March alone.
Some of that money has started to trickle back since the April truce, and the central bank held its key rate steady at 37% in April, partly to keep the lira attractive to foreign cash.
Local analysts warn that what they call "casino money" can leave as fast as it arrived.
Two things to track here. The first is the lira's exchange rate, and the second is oil.
As long as the lira stays steady and the central bank keeps rates high, the trade still pays. Once either of those slips, the math turns ugly fast.
The hottest trade in emerging markets has lived on calm waters. Oil just made the seas rougher.
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