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Mixed denomination of Turkish lira banknotes. Image Credit: Bloomberg

(Bloomberg) — Turkish assets trimmed their advance as the prospect of US sanctions over the country’s planned purchase of a Russian missile-defence system took the shine off Sunday’s landslide opposition victory in Istanbul.

The currency climbed as much as 1.8 per cent against the dollar — the most in the world as investors cheered an end to months of uncertainty going into the municipal vote — before paring its gain to 1.1 per cent. The main equity gauge, which added more than 2 per cent at the open, was trading 1.4 per cent higher as of 1.36pm in Istanbul.

“It is a classic relief rally, but its durability is questionable at this stage,” said Piotr Matys, a strategist at Rabobank in London. “Apart from fixing the economy, the Erdogan administration must find a solution to the diplomatic conflict with the US over the Russian S-400 defence system to avoid sanctions.”

Opposition candidate Ekrem Imamoglu won the redo of the Istanbul mayor’s race by a 9 percentage-point margin, which suggests President Recep Tayyip Erdogan’s AK Party won’t challenge the result again. The original vote in March had been overturned after the ruling AK Party narrowly lost. But with delivery of the S-400 system to Turkey expected to start as early as the first week of July, investors are bracing for the US to reprimand its Nato ally.

“The knee-jerk reaction was to buy the lira, but we expect rising political tensions ahead and so remain sceptical of this recent rally,” according to Win Thin, the New York-based head of currency strategy at Brown Brothers Harriman & Co.

One-month risk reversals on the dollar-lira pair, the premium traders pay for options to sell the local currency over those to buy, fell for a fourth day.

Early Election?

The leader of Erdogan’s key governing ally, Devlet Bahceli of the nationalist MHP, dismissed the prospect of an early national election, helping to remove another element of uncertainty for some traders. President Recep Tayyip Erdogan has accepted the outcome of Sunday’s election, but has hinted the new mayor could run into legal problems.

While the market is rightly welcoming the fact the results of this election won’t be contested, investors will be looking for answers for what comes next, said Inan Demir, an economist at Nomura Plc in London. “Will there be more populism? Will there be a cabinet reshuffle? Will there be increased nationalist influence?”

Apart from resolving the brewing geopolitical spat with the US, investors are eager to see authorities press on with mending the beleaguered economy, which is at risk of a double-dip recession. The lira has lost over 8% of its value this year, the worst-performer in emerging markets after the Argentine peso.

The Borsa Istanbul 100 Index, among the cheapest in developing nations, has added 4.4% in 2019.