Lira Plunge Squeezes Traders as Swap Rates Surge to 1,400%

International investors fleeing Turkish assets have created a massive bottleneck in the market for liras.

As funds scramble to unwind their positions, they’re driving the cost of borrowing the local currency to extreme levels. At one point on Tuesday, the overnight rate reached as high as 1,400%, according to data compiled by Bloomberg.

Foreign investors poured around $19 billion into Turkish assets since November, with the vast majority of these inflows going into lira swaps, securities that pay a juicy yield but lock traders into a risky currency position for a fixed term.

When President Recep Tayyip Erdogan replaced the central bank governor over the weekend though, the investors balked. Rather than wait for their swap contacts to mature, they rushed to buy back all the dollars they had exchanged for liras. However, to do that they needed to borrow the Turkish currency in the offshore market and compete with a stampede of investors all looking to do the same thing.

“As everyone tries to exit at the same time, it causes spikes in lira rates,” said Onur Ilgen, the head of treasury at MUFG Bank Turkey in Istanbul.

Another reason behind the crunch: Turkey severely restricts how much banks can lend to foreign investors via swaps. The rules, which were imposed after the currency collapse of 2018, are designed to make it prohibitively expensive for anyone to short the lira during a time of crisis. They can also make trading difficult for investors with hedged lira positions.

Lira Plunge Squeezes Traders as Swap Rates Surge to 1,400%

Violent swings in Turkish markets have been unleashed this week after Erdogan unexpectedly fired his central bank chief, sowing uncertainty about the country’s future monetary policy. Among investors, there are concerns that the central bank has lost credibility, and with inflation accelerating to almost 16% in February, the economy faces severe challenges.

Just a few weeks ago, the lira was among the best-performing emerging-market currencies and investors were returning to Turkey on the belief that former central bank Governor Naci Agbal’s policies could bring inflation under control. Now the big question is whether the country will once again embark on a path of cutting rates, how quickly it might happen.

As investors hunt for lira to close the swaps, some of the demand showed up in the local spot market. The currency was only 0.6% weaker at 7.8525 against the dollar on Tuesday -- a sign of stability after yesterday’s 8% plunge.

Still, many analysts are unconvinced that the losses are over. Renaissance Capital predicts the currency could slide a further 12% by year-end, while Commerzbank AG expects it to reach 10 per dollar.

©2021 Bloomberg L.P.

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