Longest Lira Rally Since 2014 Has Traders Betting Worst Is Over

(Bloomberg) -- Turkey’s lira has had few rallies to speak of in 2018, but the momentum built up this month may signal a turning point.

The currency extended its advance Friday to take gains over two weeks to nearly 10 percent. While some technical indicators suggest the rally has become stretched, other gauges show the rebound in one of this year’s worst-performing emerging-market currencies has further to run.

The timing is auspicious for Turkey. The central bank, often accused by investors of dragging its feet as the currency tumbled this year, meets on Oct. 25 against a suddenly more favorable backdrop. The country posted its biggest monthly current-account surplus on record in August and last week took a key step toward patching its broken relations with the U.S. as a court freed a jailed American pastor.

“It’s the typical bust-and-boom pattern you would expect during a currency crisis,” said Bernd Berg, a strategist at Woodman Asset Management AG. “First, there is panic selling with the currency finding no ground and spiking under huge volatility. Once the central bank comes to the rescue, getting ahead of the curve, the currency starts to stabilize, volatility comes down and then you see a massive rally.”

Longest Lira Rally Since 2014 Has Traders Betting Worst Is Over

The lira snapped a nine-day winning streak on Thursday, its longest in four years. Still, in the above weekly chart, the red signal line crossed above the so-called MACD line on Oct. 12, a sign that downside pressure is building on the dollar. What’s more, the MACD line on the daily chart has held below both zero and the signal line, which means dollar-lira bears are now in control.

Longest Lira Rally Since 2014 Has Traders Betting Worst Is Over

The cost of hedging against fluctuations in the currency has also dropped remarkably. The currency’s one-month implied volatility has plunged more than 4000 basis points from a peak in August, to touch the lowest level since Aug. 6 this week. That’s close to where it was before the U.S. imposed sanctions on Turkey, and makes it easier for carry traders to open fresh long positions in the lira, and lock in some of the highest yields in the world.

Longest Lira Rally Since 2014 Has Traders Betting Worst Is Over

That’s also filtering through into the rates market, with the one-year dollar-lira swap plunging to a two-month low on Thursday. The overnight equivalent rate on the contract is now just under 24 percent, in line with the central bank’s policy rate, and a sign that traders have unwound their bets for a interest-rate hike next week. That should shield the currency from any potential disappointment, and leave room for a rally if the central bank hikes.

Longest Lira Rally Since 2014 Has Traders Betting Worst Is Over

Still, another nasty inflation reading next month could slow gains. Consumer prices rose more than expected in September, driving the real policy rate back below zero. While the government says inflation is going to peak in October, the jury is still out on whether the lira’s depreciation this year is going to keep filtering through into import prices, piling pressure on authorities to do more.

Longest Lira Rally Since 2014 Has Traders Betting Worst Is Over

And as always with sharp rallies there’s the risk of a sharp short-term pullback that could shake newfound investor confidence. The 14-day relative strength index on the dollar-lira pair -- a technical gauge of a security’s strength -- is nearing 30, a level that suggests the pair is oversold and due for a correction. That’s the lowest reading in more than a year.

©2018 Bloomberg L.P.