The British Pound, Euro, Dollar, the Turkish Lira and Battlefield Europe

-GBP & JPY may now be vehicles of Turkish FX interventions.
-As EUR/USD turns screws on TRY, with TWI having surged.
-Thursday CBRT meeting could stoke EUR gains & TRY fall.

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• GBP/EUR spot rate at time of writing: 1.1080
• Bank transfer rate (indicative guide): 1.0794-1.0872
• FX specialist providers (indicative guide): 1.0916-1.0982
• More information on FX specialist rates here

The Pound underperformed last week but at least some of the price action in Sterling was consistent with an exchange of gunfire between Turkish monetary authorities and the market in a battle to keep the Lira from falling into an abyss.

Lira depreciation, which may be more than just natural depreciation pressures, is increasingly being felt through the EUR/USD rally that has driven a surge in the trade-weighted Euro in recent months.

But GBP/USD and JPY/USD sales appeared several times to squash GBP/EUR and lift EUR/JPY. This was just as a rallying EUR/USD was advancing on EUR/TRY, pushing it to new lows, reflecting extreme pressure on the Lira.

EUR/USD might be the market’s preferred battering ram for EUR/TRY in the event this week’s Central Bank of Turkey rate decision draws protest from investors. It’s in this kind of market that GBP/USD might be found falling as USD/JPY rises with EUR/USD, which happened several times last week.

The first chart below is messy with five exchange rates at 15-minute intervals but demonstrates the relevant price action. Clicking will open it in a new tab.

The combined impact on the Eurozone trade-weighted currency index, the weightings for which are at the bottom, may be becoming an important influence because the index has surged in recent months and above levels seen in 2017.

Above: USD/JPY with GBP/USD (blue line, left axis), EURUSD in orange, EUR/JPY in black and GBP/EUR in yellow.

The first vertical red trendline on the left side of the chart and the trading in 15-minute periods immediately after it cover the early morning hours around 09.45 in London on Wednesday 12 August and are just one example of similar price action that took place through last week. The others are labelled B, C and D respectively and are littered along the path to Friday.

In the first instance and shortly after the first period the EUR/USD rate (orange) can be found rising in an attempt to reclaim the 1.18 level which, when combined with a higher USDTRY, lifts EUR/TRY and puts the Lira under pressure. But as EUR/USD rises, the upward move in EUR/JPY (black line) and downward move in GBP/EUR (yellow line) are exacerbated by a sudden rise in USD/JPY (red & green) and fall in GBP/USD (blue).

Neither of the latter moves were necessary for an adjustment in the aforementioned rates and the fact that at least one of them took place is somewhat out of the ordinary because GBP/USD and EUR/USD tend to move in the same direction as each other rather than opposing directions. Period B on the above chart seems to show the EUR/USD up-move being restrained in a similar way again. Likewise with period C. 

Sterling and Yen sales might be a sophisticated defence of the Lira by Turkish monetary authorities, drawing on Bank of England and Bank of Japan FX swap lines that have for a while been rumoured but were never in fact actually announced or disclosed. Comments are being sought. 

These sales lead to downward pressure on GBP/EUR just as USD/JPY rises, magnifying the uplift of an already stretched trade-weighted Euro in a manner that might enable them to work like a cowboy’s lasso around EUR/USD and EUR/TRY, or a dogwalker's choke chain. 

They would also produce Dollars that can be used to either hit USDTRY on the head, or tinker with the trade-weighted Euro using other European exchange rates.

Above: USD/TRY shown at daily intervals with EUR/USD in orange and EUR/TRY in black.

Many analysts perceive the authorities’ capacity for defending the Lira to be near exhausted and cite a recent lack of liquidity in the local foreign exchange market as evidence for this, but what if some of that liquidity and activity simply moved to the major exchange rates? From, say, mid-May onward when Turkey was rumoured to have signed those swap agreements? This period saw USD/TRY back below 7.0 before the exchange rate flattened.

Turkey’s defences broke shortly after the EUR/USD consensus became trigger happy in late July, in moves that led EUR/TRY to overtake USD/TRY on the chart. But now and to this particular member of the Pound Sterling Live editorial team, it seems authorities are playing ‘hammer and dance’ with major currencies to influence EUR/USD and the Euro TWI, which are both at extremes.

It seems the market moves silly money through EUR/USD either in response to narrative or in order to lift the EUR/TRY rate, while Turkey looks to simultaneously lift the trade-weighted currency elsewhere just as the EUR/USD horse charges at the Lira in the road. 

That would maximise the cost for the Eurozone economy and inflation outlook while potentially reducing the headroom that EUR/USD left to rise within a trade-weighted context. This implies and assumes that level of the trade-weighted index has become a problem, necessitating a countervailing adjustment from elsewhere in the barometer before EUR/USD can make further gains.

For readers who accept the possibility and are willing to assume the existence of undisclosed swap lines, it’s also the case that defensive GBP/USD and JPY/USD sales produce a supply of Dollars that need not be thrown back at the Lira directly. With trade-weighted Euros and Dollars at extremes, the Lira might be defended by a continuous dance around these indices, Turkey’s TWI, the above referenced majors and other currencies.

Above: European Central Bank graph showing respective trade-weightings of the Euro.  

Such a strategy by Turkish authorities would enable some recycling of the hard currency produced by the swap lines. Intervention may be likely in markets where EUR/USD is rising strongly, although EUR/USD might require a broad lift to all European boats in order to really rally from here.

Gains in other currencies relative to the Dollar would lessen the strengthening of the Euro against non-Dollar currencies and constrain the overall uplift in the TWI, facilitating more EUR/USD gains. Turkish intervention efforts might be most succesful in a market where there is a Dollar recovery or simply a chequered performance pattern among major currencies.

This is yet more mudd to the watery outlook for currencies but one thing that might be safe to assume as a result of it is that if the market is going to succeed in driving the Lira into an abyss, it probably won’t be succesful in the absence of a higher Pound-to-Euro rate.

Also, given the larger run-up in EUR/USD and defensive selling pressures in GBP/USD, an eventual meltdown that relieves upward pressure on EUR/USD and downward pressure on the Lira might be likely to produce a rising Pound-to-Euro rate. BUT with GBP/USD and GBP/EUR both battlefields, price action beforehand could be volatile. USD/CHF, USD/SEK, USD/PLN and USD/NOK price action is also highly relevant for TWI reasons.

There are UK retail sales and flash PMI figures due out late in the week ahead. These could generate momentum that’s open to being exploited.