Turkish Lira Sell-off Could Lift USD/TRY to 8.50 Without Policy Reform Says Commerzbank

-TRY heads for new lows, may overshoot forecasts without reforms.
-USD/TRY could rally to 8.50 if unorthodox rate policy not scrapped.
-Policy reforms & bailout only way to save TRY says Commerzbank.
-Technical analysts see USD/TRY at 8.10 as forecasts look for 8.20.

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The Lira continued in the direction of new record lows Tuesday and could fall as far as 8.50 in the months ahead if Turkey’s unorthodox approach to monetary policy goes unreformed, according to analysts at Commerzbank. who also say an International Monetary Fund (IMF) bailout could now be an inevitability.

Turkey’s Lira has fallen by more than 30% against many major currencies this year in what has been an even worse performance than that seen by the troubled South African Rand, but it continued back toward the 8.0 handle against the Dollar on Tuesday as new record lows beckoned.

Tuesday’s losses came amid a widespread rebound in U.S. Dollar exchange rates, which rose sharply after the World Trade Organization awarded the European Union permission to place tariffs on U.S. aircraft in a judgement relating to a long-running dispute between Brussels and the U.S.

“Turkey’s announcement unilaterally raises tensions in the region and deliberately complicates the resumption of crucial exploratory talks between our NATO Allies Greece and Turkey,” says Morgan Ortagus, a spokesperson for the U.S. State Department. “Coercion, threats, intimidation, and military activity will not resolve tensions in the Eastern Mediterranean.”  

The move toward 8.0 only continues losses that were already set in train on Monday when markets responded to a weekend announcement from Turkey, which notified the international community that it intends to resume resource exploration work in a disputed part of the East Mediterranean. 

Above: USD/TRY shown at daily intervals. 

These declines simply build on those that wracked up last week when former head of Turkstat Birol Aydemir, now an opposition politician, alleged that the country’s economic books have effectively been cooked including estimates of GDP growth, employment and inflation. 

This revelation put an end to the short-lived stability that followed a September 25 decision by the Central Bank of the Republic of Turkey to raise its interest rate by 200 basis points to 10.25%, which took the market by surprise and temporarily spared the ever-depreciating Lira from intervening falls. 

“The lira’s underlying problem is the lack of credible inflation targeting by the central bank, which is bound to ultimately debase the currency. There is no ad hoc market intervention or policy tweaking which can avert this outcome," says Tatha Ghose, an analyst at Commerzbank. “The underlying monetary philosophy remains unorthodox. CBT’s free FX reserves have dropped to negative and capital outflows are continuing.” 

Turkey’s Lira has been in a depreciation spiral for more than a decade although since 2018 at least some of this has resulted from market perceptions that the central bank has been politically compromised, a situation that’s not been helped by the rhetoric of President Recep Erdogan, who’s argued that high interest rates lead to high inflation and that the only way to curtail price pressures in the economy is to cut rates. 

Above: USD/TRY shown at weekly intervals alongside GBP/TRY (black line, left axis) and EUR/TRY (blue line, left axis). 

That’s precisely the opposite of how the rest of the world approaches interest rates, and goes some way toward explaining the severe selling pressures that have lifted USD/TRY from 3.77 at the beginning of 2018 to nearly 8.0 on Tuesday. EUR/TRY and GBP/TRY have risen by similar magnitudes, in each case denoting depreciation pressures that have further raised Turkish inflation and served as an additional headwind to the economy. 

“Rate hikes would have worked if they had been a credible part of a long-term traditional monetary policy to bring back inflation to the 5% target. But, they are not – President Tayyip Erdogan insists on unconventional monetary policy and still calls for low interest rates,” Ghose says. “The market views rate hikes as a temporary stop-gap which will be reversed as soon as the lira has stabilised for any length of time – and if the market sees through a rate hike, then it does not work. This is what we are observing in latest lira movements.”

Authorities have been able to slow the Lira's depreciation using central bank foreign exchange reserves of the CBRT and by leveraging the balance sheets of domestic banks, although hthe reserves coffers are now believed to have run empty while commercial lenders have all but been squeezed dry. 

Turkey is unable to produce the foreign currency supply needed to prop up the Lira since travel and tourism have been curbed due to the pandemic, Meanwhile, Turkey is engaged in multiple geopolitical disputes that risk seeing the already crumbling, coronavirus ravaged economy clobbered with sanctions. 

Above: USD/TRY shown at monthly intervals alongside GBP/TRY (black line, left axis) and EUR/TRY (blue line, left axis). 

“It is difficult to envisage orderly outcomes which do not involve the IMF,” says Ghose. “Policymakers could always promise their electorate to repay institutional loans early and re-establish control. Still, the problem is that we are unlikely to get from here to there without some more damage to the exchange rate. This is why USD-TRY is likely to overshoot in coming months. On the base-case assumption of an orderly as opposed to disorderly resolution, and some restoration of central bank independence as part of reforms, we forecast USD-TRY to gradually stabilise in the 8.00 range over the coming year.” 

Ghose forecasts USD/TRY will rise to 8.20 by year-end, which implies a further -3% fall in the coming months, but has warned clients that this forecast could easily be overshot and that it may be the case that USD/TRY has to rise all the way to 8.50 before the government and authorities change course. 

Before then however, the Lira must first weaken or the Dollar strengthen sufficiently for USD/TRY to make it above the 8.0 threshold. After which point the exchange rate is likely to target 8.10 in the first instance, according to technical analysis from Commerzbank.

"USD/TRY has made a new all-time high, at 7.9583, whilst still targeting the major psychological 8.0000 mark. Above it lies an hourly 0.01 x 3 Point & Figure vertical upside target at 8.1000," says Karen Jones, Commerzbank’s head of technical analysis for currencies, commodities and bonds. “Longs should tighten their take profit stops since negative divergence can be seen on the daily RSI. Having said that upside pressure should remain in play while the cross stays above the current October low at 7.6230.”

Above: Commerzbank technical analysis slide.