Good Sunday All;
USDTRY surged to 3.5935 in the European session Friday, a new all-time high. There are rumors that the Turkey’s central bank intervened in the FX markets attempt to slow the selling of TRY. Clearly the CBT’s decision to raise its benchmark rate by 50bp to 8.0% (increasing upper band of marginal funding rate by 25bp to 8.50%) was not effective in convincing investors to stay in TRY assets. One reason was the RRR was lower to ease lending conditions in order to help the decelerating economy yet soften the tightening effect / conviction. Political concerns have been compounded by the European Parliaments discussion to temporarily suspend Turkeys EU accession path.
The inability for higher interest rate to halt TRY liquidation, stems from speculation that the mix of policy actions are being manipulated by the government (lack of CBT independence). The “surprise” aspect of the CBT hike was not that the underlying fundamentals need support, only when the CBT would have the maneuverability to make the move. There is lingering concern that should the economy demand additional measures, CBT will lack the independence to take action. In our view, so far the CBT has failed to deliver the needed interest rate adjustment to slow the lira depreciation and is unlikely to have the freedom moving forward. This suggests that further lira weakness should be anticipated. We are currently forecasting an additional rate hike in early 2017 of 50bp. But likely to little to late.
The CBT comments regarding the lira bearish trend and effect on inflation seem to be on point. There is increasing concern that Turkey is about to trigger a debilitating inflation – exchange rate death spiral, especially if oil prices continue to move higher. Falling aggregate demand will not be great enough to offset rising exchange rate risk to inflation outlook.
Concerningly, key political advisors to the PM still suggest that interest rates should come down to address soft economic activity and that inflation is a non-issue, without understanding the market implications of cutting rates while developed markets yields are going higher. There is increasing market perception that tightening is for optics rather than economic necessity; one-off hikes rather the tightening cycle.
We have a hard time forecasting where real interest rates reach to limit lira selling but were are clearly not there. We remain long USDTRY on fundamental reasons with a target to 3.600 mid-term.