Turkish Lira’s Recovery Faces CBRT Test after Month of Outperformance Inbox

- TRY facing CBRT test after a month of outperformance
- As sceptic, cynical market awaits invitation to sell TRY
- Steady rate hand & inflation message key to recovery

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The Turkish Lira has been an unlikely outperformer over the recent month but will need the Central Bank of the Republic of Turkey (CBRT) to defy pressure from Ankara for a reduction of interest rates this Wednesday and in the months afterward if its recovery is to continue.

Turkey’s often troubled currency rose against a vast majority of its most frequently traded emerging and developed market counterparts in the month to July 14, having been eclipsed by only the Mexican Peso and Japanese Yen respectively.

The Lira’s recent outperformance is all the more eye-catching for its occurrence alongside a rebound in the U.S. Dollar but Wednesday’s decision on where to place the 19% cash rate until August 12, due out at 12:00 London time, is key to the currency’s further recovery from June’s all-time lows.

“Delay to an easing cycle will be a crucial step towards rebuilding the inflation targeting credibility of the central bank. Yet, investors may remain worried about earlier comments by President Erdogan that it is imperative to lower rates with July/August critical for the process,” says Anezka Christovova, an analyst at J.P. Morgan in an early July note.

Economists widely expect borrowing costs to be left unchanged but many cite the experiences of previous CBRT chiefs for thinking it’s only a matter of time before Governor Sahap Kavcioglu gives-in to Ankara’s demands by cutting borrowing costs.

Above: USD/TRY shown at daily intervals with Fibonnaci retracements of March 2021 rally, GBP/TRY and EUR/TRY.

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A rate cut that comes before the CBRT has made progress in its attempt to return inflation to its 5% target would vindicate a sceptical commentariat for having grown cynical in recent years and would likely deal a crushing blow to the Lira.

“We refrain at this point from calling for a rapid increase in USDTRY in the short run (e.g. to 9.40) given that international long lira positioning is light and given that the recent increase in inflation is likely to lead the central bank to avoid a rate cut at its July meeting. The lira is also currently very cheap in [real-equilibrium-exchange-rate] terms by historical standards,” says Nimrod Mevorach, an emerging market strategist at Credit Suisse.

“We would look to buy USDTRY on a possible dip to the mid-June low of around 8.30,” Mevorach says.

Inflation rose to 17.53% in June and the highest since 2018, data showed last week, while price growth excluding volatile energy costs and regulated price items like alcohol and tobacco was not far behind when rising by an annualised 17.48%.

Increased commodity prices and 2021’s currency depreciation are among the foremost factors to have lifted inflation rates back toward record levels that prevailed after the “Lira crisis” in 2018, which saw USD/TRY rise by 42.6% for the year including a 20.8% increase in one August week alone.

Above: 02-year and 10-year Turkish government bond yields shown at weekly intervals.

Governor Kavcioglu has for his part several times reiterated an April 2021 commitment that interest rates are to be kept above the level of actual inflation as well as expected inflation until a permanent fall in consumer price growth back to the 5% target has been achieved.

But repeated calls from President Recep Tayyip Erdogan to cut rates this summer have occasionally unnerved the Lira since Kavcioglu was appointed in March following the sudden firing of predecessor Naci Ağbal, who’d announced a 2% interest rate rise to 19% just days before he was replaced.

“Our economist now forecasts 150bps of cuts by the end of the year starting in October (see here). This compares to the previous forecast for 300bps of easing starting in September,” says J.P. Morgan’s Christovova.

Governor Kavcioglu is the fourth appointee to lead the central bank in little more than the last two years while the cycle of hirings and firings - often followed by interest rate cuts - is one reason why the analyst community has grown cynical.

That deeply ingrained pessimism is why some analysts are already telling clients to sell the Lira and buy Dollars in response to any declines in USD/TRY, as they anticipate that a rate cut will be announced over the coming months irrespective of whether the bank is able to get runaway inflation rates under control.

But it’s also a reason why a continued steady hand from the CBRT may sooner rather than later prove to be uplifting of the Lira.