Euro-Dollar Bulls Drawn into Run on Turkish Lira but Are at Risk from Authorities' Interventions 

- EUR/USD's recovery fund bulls drawn into run on TRY in August.
- Rally above 1.17 may be as much about the TRY as anything else.
- TRY depreciation neccesitates gains for EUR/TRY via EUR/USD.
- But speculators' profit-taking, TRY intervention a risk to EUR/USD.

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• EUR/USD spot rate at time of writing: 1.1782
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The Euro-to-Dollar rate was rallying higher Tuesday in moves that may have had more to do with keeping pressure on the Lira than with any bearish outlook for the greenback or brightening Eurozone economic story after the market was drawn into aiding a run on Turkey's currency late in July. 

Europe's single currency has spent the early part of August consolidating explosive gains made in late July, which many saw resulting from mounting investor contempt for the greenback and optimism about the Eurozone economic outlook that had been cultivated and nurtured by EU recovery fund developments. 

But it also came amid the latest chapter in a long and ongoing depreciation of the Turkish Lira resulting in part from controversy over Central Bank of the Republic of Turkey (CBRT/TCMB) monetary policy

"Speculators lifted their dollar short across ten IMM currency futures to a nine-year high in the week to August 4. However, just like the previous five weeks, the expanding dollar short position was almost solely driven by another rise in the euro net long to a fresh record of €22.6 billion," says Ole Hansen, head of commodities strategy at Saxo Bank ."The dollar’s short-term outlook remains closely tied to developments between these two major currencies."

July 20 saw leaders back the EU's mammoth €750bn economic aid package, which lifted EUR/USD above 1.16 and offered a neat explainer when EUR/USD broke 1.17 and began aiming even higher from July 23. 

Above: Euro-to-Dollar rate at daily intervals alongside USD/TRY (black line) and EUR/TRY (orange line).

Those gains saw investors go from 'net short' of the Euro to 'net long' and got analysts talking about levels above 1.20.

But price action played out alongside the perceived failure of CBRT attempts to prop up the ever depreciating Turkish Lira, which has automatic implications for EUR/USD and other major currencies including those of countries thousands of miles away.

"TRY is at 7.32 today and while trade will stay choppy in the way CNY trading doesn’t, the risks are still of an ultimate move in the same direction – much lower," says Michael Every, a global strategist at Rabobank. "Once the FX reserves run out, markets can get pretty volatile. For example, Turkey. President Erdogan declared yesterday that he wants further interest rate *cuts* and that “God willing, they will go down further,” as Turkey ‘flexed its military muscles’ (according to the press) and launched naval exercises off two Greek islands while announcing it will explore for energy in the area. That’s a move which could cause issues with any potential IMF bailout."

The CBRT has become little more than another arm of government under the current administration, which has triggered annual currency depreciations that have averaged high double-digit percentages in the last decade. 

2020's fall followed a series of interest rate cuts from the CBRT that some analysts and investors say need to be reversed.

Above: EUR/USD at daily intervals with Dollar Index (orange line). A rising EUR/USD often prompts a falling Dollar Index.

"The probability of USD-TRY overshooting to 8.50 or beyond has increased. The various capital controls and restrictions, which Turkish policymakers were using, obviously no longer suffice to keep the lira stable, but as base-case, we should anticipate more of these," says Tatha Ghose, an analyst at Commerzbank. "There were additional FX interventions by state banks and other players, which kept USD-TRY in a completely flat channel through much of June and July. The resource for such interventions probably ran out as FX reserves continued to plummet and bank balance sheets developed a large open FX gap."

USD/TRY price moves often garner the bulk of attention during times of Turkish trauma but the single largest slice of the country's goods and services trade is accommodated by EUR/TRY, which makes the latter a better engineer of economic pain and a more effective instrument of coercion. 

This is important because EUR/TRY is one half composed of EUR/USD, which must rise in order to facilitate a Turkish currency depreciation. EUR/TRY is effectively EUR/USD over TRY/USD. That relationship was demonstrated in late July when authorities were still having success in suppressing USD/TRY but appeared powerless to prevent the ascent of EUR/TRY. 

The rising EUR/TRY resulted from a strengthening bid for EUR/USD, aided by excitement over the EU recovery fund, which helped close the earlier gap between the former and USD/TRY. A rising EUR/TRY rate is a fundamental prerequisite for Turkish currency depreciation, which then enlists a rising EUR/USD as a necessary ingredient too.

Above: Euro-to-Dollar rate at weekly intervals alongside USD/TRY (black line) and EUR/TRY (orange line).

"If the main currencies Turkey needs – dollars and euros – were available via swap lines, this would be a valuable liquidity management tool for sure, but ultimately completely unrelated to the fundamental imbalance at hand. And, in any case, these main currencies are not available for now," Ghose says. 

Depreciation pressure can alternate between USD/TRY and EUR/USD, although meaningful declines in the Euro might be unlikely without profit-taking among Turkey's tormentors or direct intervention from authorities.

With rate hikes aside, selling EUR/USD would be the most efficient and effective defence of the Lira for Turkish authorities.

Turkish commercial banks collect more Euros than they do Dollars while EUR/USD sales would weigh on the all-important EUR/TRY before also furnishing the country with a supply of the greenback that could subsequently be used to suppress USD/TRY.

The Euro slumped repeatedly in the 2018 Turkish sell-off, slowing the increase in EUR/TRY while also making USD/TRY work harder for a Lira devaluation.

Ultimately however, selling EUR/USD into a Lira depreciation is tantamount to a bet that either Turkey capitulates by raising interest rates or that President Recep Tayyip Erdogan prevails in a kind of tussle with global markets that has ruined many an entire country before him and/or the CBRT.