Lira Traders Brace for Impact After Erdogan Ousts Central Banker

(Bloomberg) -- A rally that had turned the lira into the world’s best-performing currency since early May is probably over after President Recep Tayyip Erdogan reignited concerns about his influence over monetary policy.

Turkish stocks and bonds are also set to decline as investors digest Erdogan’s decision to use his executive powers to dismiss central bank Governor Murat Cetinkaya over the weekend, about a year before his term was due to end. He was replaced with deputy Governor Murat Uysal.

“No one will be satisfied after this change,” said Hasnain Malik, a Dubai-based strategist at Tellimer. “If the central bank cuts rates, it will further hit credibility, undermining confidence in the economy.”

Before the weekend, Turkish assets had been rallying after a dovish turn in central banks across developed markets triggered a desperate search for yield. The advance was given a big boost after U.S. President Donald Trump softened his threats of sanctions over the purchase of a Russian missile system and Erdogan accepted an opposition victory in last month’s mayoral elections in Istanbul.

Goldman Sachs Group Inc. and Barclays Bank Plc both said last week that conditions were turning in the lira’s favor, especially with Turkish real rates among the highest in the world.

If the lira plummets on Monday, it would give bears the justification they needed for keeping bets against the currency at the highest level in emerging markets, according to risk-reversal contracts. They’ve been waiting patiently on the sidelines as the lira advanced about 10% against the dollar since May 9.

Here’s what analysts said:

Malik at Tellimer:

• “Turkey risks squandering the gains from its narrowing current-account deficit and the wider berth given to the lira following the change to more benign expectations on U.S. rates and dollar.”

Nigel Rendell, a London-based senior analyst at Medley:

• “It’s undoubtedly bad news for Turkish assets. Once again Erdogan is interfering in the operation of the central bank because he thinks he knows best, which he doesn’t!”
• “It further dents central bank and policy credibility just at the point when inflation was beginning to decline”
• “The likelihood of a sell-off in the lira brings any near-term rate cut into question. The markets are likely to mark the lira lower.”

Cristian Maggio, the head of emerging-market strategy at TD Securities in London:

• “We will almost definitely see a negative lira reaction on Monday”
• “Clearly this is an attempt to have rates lowered. Otherwise Erdogan would not be replacing Cetinkaya a year ahead of time. Front-end rates may fall to price in more easing than already expected. But longer-term rates may move in the opposite direction. It will also be a negative for equities”
• “If the lira sell-off causes panic in the market like August of last year, the answer is yes,” he said in response to a question about whether the fallout of Erdogan’s decision to replace Cetinkaya will impact Turkish -- or other -- banking systems
  • “However it should be short term and reversible for most other EM assets. As far as Turkish banks are concerned, any lira sell-off will add pressure on local lenders. Especially the state-owned” banks
• “Domestically we’re looking at a recession this year and potential re-acceleration ‎in CPI. Also the Central Bank of the Republic of Turkey may be forced to hike at a later stage.”

Piotr Matys, a London-based strategist at Rabobank:

• “By abruptly dismissing Cetinkaya, Erdogan reminded everyone who is in charge of monetary policy. The decision is set to undermine credibility of the central bank, which may start unwinding the emergency rate hike announced in September much faster than previously anticipated, starting with a large cut at the upcoming meeting”
• “If there is anything positive about it, it’s that investors will have the entire weekend to calmly assess potential implications and perhaps the sell-off on Monday when the markets reopen will not be as substantial as it would have been if the decision was announced on a weekday.”

Inan Demir, an economist at Nomura International in London:

• “With his experience as deputy governor and before then as head of treasury of a large bank, there’s no question the new governor is well prepared”
• “However, the ease with which the former governor was removed sets a dangerous precedent, which is bound to have an impact on monetary policy conduct going forward”
• “Consequently, I think the markets will move to price in a larger cut at the next MPC meeting.”

Timothy Ash, a strategist at BlueBay in London:

• “This was an opportunity to refresh and renew the CBRT with someone from outside with real monetary policy gravitas. And that opportunity has been wasted”
• “Cetinkaya was fired in the end because he didn’t cut rates fast enough -- ironically recent TRY stability was likely due to Cetinkaya’s mea culpa on rates since September last year. The assumption is the new guy was hired because he will cut rates on demand from the presidential palace.”
• Ironically, replacing Cetinkaya “likely makes it more difficult for the CBRT to cut rates as the risk now is that the market reacts badly to this HR change at the central bank.”

Ziad Daoud, Bloomberg’s Dubai-based chief Middle East economist:

• “If Erdogan’s aim was to get lower interest rates, then the decision to replace the governor could backfire. The economic conditions were set for a rate cut later this month: inflation is dropping, growth is weak, the lira is stabilizing, and expected cuts from the Federal Reserve mean the global environment is supportive. Now there’s an additional credibility constraint, with financial markets certain to scrutinize the motivation and magnitude of any easing”
  • “Investors will question whether it was really warranted by economic data, or if it was delivered under pressure from the government”
• “The decision adds a new economic unknown to existing geopolitical risks facing Turkey”
• “The delivery of the S-400 Russian missile system, expected soon, has strained the relationship with the U.S. and could lead to sanctions. This may result in a repeat of last summer, when the combination of U.S. sanctions and the lack of credibility from the central bank sent the lira into a free fall.”

--With assistance from Netty Ismail, James Ludden and Claudia Maedler.

To contact the reporters on this story: John Glover in London at johnglover@bloomberg.net;Cagan Koc in Istanbul at ckoc2@bloomberg.net;Paul Wallace in Lagos at pwallace25@bloomberg.net

To contact the editors responsible for this story: Dana El Baltaji at delbaltaji@bloomberg.net, Michael Gunn

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