Here's What Investors Say About Turkish Lira's Short-Lived Rally

(Bloomberg) -- The Turkish lira’s attempt at a rally after Recep Tayyip Erdogan’s election victory proved fleeting as concerns about the independence of the nation’s central bank and policy direction prevailed.

The currency erased gains of as much as 3.1 percent as mounting trade tension between the U.S. and China weighed on sentiment. Stocks and bonds also reversed their advance.

The lira’s “trajectory will depend on how the macroeconomic policies develop post these elections, including the question about the central bank’s independence,” Sue Trinh, the head of Asia foreign exchange strategy at Royal Bank of Canada in Hong Kong, wrote in a report.

Capital fled this quarter as Erdogan fought with his own central bank, insisting against economic orthodoxy that interest rates need to be lowered, despite double-digit inflation. The lira has slumped 19 percent this year, the worst performer among developing peers after Argentina’s peso.

Still, the cost to hedge against fluctuations in the lira over a one-week period fell by the most since at least 2004, and options traders, who were more bearish on the lira than any other emerging-market currency last week, are now more pessimistic on South Africa’s rand and Russia’s ruble, according to one-month risk reversals.

  • Lira slipped was little changed at 4.6791 per dollar at 2:53 p.m. in Istanbul
  • Its one-week implied volatility fell to 23 percent from 36 percent on Friday
  • The yield on the government’s 10-year bond rose 47 basis points to 16.76 percent, and the rate on Turkey’s dollar-debt due 2028 climbed 11 basis points to 7.16 percent
  • Borsa Istanbul 100 Index fell 0.6 percent after jumping as much as 3.7 percent
  • Risk reversals showed the premium on contracts to sell the lira versus the dollar in a month’s time over those to buy were at 2.61 percentage points, down from 3.14 percentage points Friday
  • Five-year credit default swaps edged up five basis points to 306, according to CMA prices
  • Erdogan won 53 percent of the presidential vote to 31 percent for his closest challenger, Muharrem Ince of the secular Republican People’s Party or CHP, with more than 99 percent of ballots counted, according to government news agency Anadolu. The country’s electoral board hasn’t published official results yet, but it confirmed that Erdogan won

Here’s a roundup of what investors and analysts said:

Central Bank Independence

Takeshi Yokouchi, (senior fund manager at Daiwa SB Investments Ltd.)

  • Market participants are concerned about the possibility that he will increase pressure on the central bank to have lower interest rates; the central bank asserted its independence during the election campaign and managed to halt declines in the lira, but there’s uncertainty whether such a commitment would continue after this election
  • Read More: Erdogan Vows to ‘Deal’ With Interest Rates After Vote, AA Says
  • Inflation has been accelerating with the weaker lira, while the country has a current-account deficit, and with the persistent weak sentiment toward emerging markets, the lira and Turkish assets will probably remain among the most vulnerable to any selloffs
  • Yokouchi said he is keeping an underweight position on Turkey in his portfolio

Unorthodox politics

Mitul Kotecha (senior emerging markets strategist at TD Securities)

  • Market values “stability and continuity” more than uncertainty over a change in regime; lira could rise to 4.55-4.60 per dollar
  • However, a change toward economic and political orthodoxy is very unlikely to follow Erdogan’s victory, so don’t expect TRY gains to be sustained; the lira is likely to eventually resume its negative trajectory

Fiscal Pressure

Phoenix Kalen (emerging-markets strategist at Societe Generale)

  • The president seems to have promised to force down interest rates during his campaign speeches, which suggests that the central bank’s monetary policy independence remains at risk
  • Societe Generale maintains its existing trade recommendation of short lira against South Africa’s rand because of likely divergence in policies and economic performance between the two countries
  • It retains the forecasts of dollar against lira at 5.18 by year-end and 5.5 by the middle of next year

Challenging Outlook

Paul Greer (fund manager for emerging-market debt at Fidelity International)

  • Turkish markets should enjoy a “small relief rally” given that the political uncertainty has now been removed
  • However, medium to long-term picture for Turkey remains challenging and the much required structural deep reforms are now unlikely to materialize anytime soon
  • The company remains neutral in Turkish local markets but hold a small overweight in Turkish external credit, which is attractively priced relative to EM peers

New Macro Policy Framework Needed

Morgan Stanley’s note to clients

  • While there could be a short-term recovery as political uncertainty is removed after Sunday’s vote, a new macro policy framework is required for sustained gains
  • “The election result suggests status quo, which in recent years has not produced positive results for asset prices,” analysts including Ercan Erguzel say
  • “External funding needs are large and competition for global capital flows is intense. Any recovery in local currency bonds or FX would require a more benign external environment, which we do not expect to be forthcoming”
  • A test of the June low around 4.45-4.47 is possible, expect this to be the limit of any rally in the absence of any fundamental changes

‘Guessing Mode’

Commerzbank note to clients

  • Erdogan will feel empowered with his renewed mandate and is likely to take more control of economic policies more directly. We should expect a combination of expansionary monetary and fiscal policies, which will aim to boost growth further
  • There’s a distinct possibility the average interest rate ends up lower than it is now. It’s quite likely Erdogan will push for cheap credit for smaller, domestic companies via the state banks
  • The central bank will also be hesitant to raise interest rates when the lira comes under pressure. The FX market will re-enter a “guessing mode” about the central bank’s ability to hike rates - and that is a disaster

©2018 Bloomberg L.P.

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