Lira Traders, Burnt Eight Times, Hope 2021 Will Be Different
(Bloomberg) -- Lira traders chastened by the currency’s almost 25% collapse this year are daring to believe 2021 will be different after President Recep Tayyip Erdogan’s surprise flip to more orthodox policies.
The nation’s latest currency crisis culminated in Erdogan’s decision to fire the central bank governor, the resignation of the president’s son-in-law as economy czar, and a hefty rate hike. The lira climbed on Wednesday after the new governor Naci Agbal said he’d tighten policy, helping pare the currency’s eighth straight year of losses. Still, investors want more evidence the switch in direction is more than just a temporary maneuver.
The lira’s decline is illustrative of Turkey’s troublesome past decade, in which political turmoil and policy missteps have eroded confidence in the $750 billion economy. To support the sinking currency, Turkish banks sold more than $100 billion this year alone, according to Goldman Sachs Group Inc. The currency traded at an all-time low of 8.5793 per dollar as recently as Nov. 6. It was at 1.5439 per dollar on Dec. 31, 2010.
The shift to orthodoxy “will probably continue for some time, as there are no reserves left to burn and no elections approaching,” said Viktor Szabo, a senior fixed-income manager at Aberdeen Asset Management in London. “However, if things normalize there is always a risk of a policy U-turn.”
The most recent bout of lira weakness was triggered by just such a pivot when the central bank stunned traders in October by keeping rates on hold instead of delivering a hike. Erdogan puts a premium on growth and job creation, and has repeatedly rattled local markets with the unconventional view that higher rates cause higher rates of inflation.
After the lira dropped to a record low at the start of November, Erdogan’s shakeup of his economic team sent it soaring more than 10% in as many days. While the currency has been largely range-bound since then, it’s still on track for the worst drop this year in emerging markets after Argentina’s peso.
“What we see in the current lira exchange rate is a lot of hope that monetary policy will take a conventional path in the future,” said Ulrich Leuchtmann, head of currency strategy at Commerzbank AG in Frankfurt. “The real test will come when monetary policy hurts in terms of real economic performance.”
The nosedive and subsequent rebound have drawn comparisons with the 2018 lira crisis. Officials failed to sustain tight policy in the wake of that collapse, ultimately setting the stage for the slump this year, Leuchtmann said. Whether it will be different this time is “more difficult to forecast than ever,” he said.
The lira extended gains on Wednesday after Agbal pledged a tight monetary policy stance in 2021, when the central bank expects the lagged impact of a weak currency and commodity prices to pose risks to the inflation outlook. The central bank will also try to amass foreign reserves when market conditions are right, he said as he unveiled his monetary and foreign-exchange policy paper for next year. The central bank meets next on Dec. 24, with expectations high for another hike from the current level of 15%.
Piotr Matys, a currency strategist at Rabobank in London, says the lira could appreciate next year, and may even strengthen below 7 per dollar. “The risk is that if Governor Agbal boosts expectations for a rate hike and fails to deliver, this will dent his credibility, which he cannot afford to do at this very early stage of being charge of the central bank of Turkey.”
If Washington and Ankara can improve relations after the U.S. imposed mild sanctions over Turkey’s purchase of Russian S-400 missile systems, it would prompt a fresh rally, according to Coex Partners’ macro economist Henrik Gullberg in London. The lira will trade between 7.25-7.50 per dollar in the first half amid broader weakness in the greenback, Gullberg said.
While the new policies seem to be going in the right direction for now, lira traders have been burnt too often to give officials the benefit of the doubt. Leuchtmann at Commerzbank says he’s “not convinced” yet on the government’s change of direction and sees the lira depreciating to 8.75 per dollar by end-2021, a drop of about 10% from current levels.
Erdogan served up a reminder of the lira’s fragility at a meeting with businessmen in Ankara on the eve of the Nov. 19 central bank decision. The currency briefly extended its drop to as much as 1.1% after his warning that investors could be “crushed” by high interest rates.
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