More Cold Turkey: Is It A Currency Crisis Or Not?

On Wednesday, in a post that was simultaneously tragic and hilarious, I documented Turkey’s unfolding currency crisis.

I won’t recount the backstory here as you can read it for yourself (see “Cold Turkey: Currency Crisis Looms For NATO’s Favorite Autocrat“), but I did want to highlight a new note out this morning from TD.

It’s important that you keep abreast of what’s going on in Turkey as the country is a critical piece of the geopolitical puzzle.

Much to the dismay of Moscow, Berlin, and Washington, there’s no getting around the fact that you can’t talk about Syria or the refugee crisis without including Ankara in the discussion. Further, it’s looking more and more as if Turkey may be the epicenter of the next emerging market meltdown.

With that in mind, consider the following from TD.

Via TD Securities:

The debate is officially open–is the Turkish lira heading for a new currency crisis (the last was in 2001), or is it rather the investment opportunity of a lifetime? We don’t believe in a catastrophic outcome for Turkey, but don’t think that the lira is set for a swift recovery either, unless certain conditions are met. More importantly, long-term fundamental valuations have nothing to do with this situation, so other factors will have to be observed to trigger a potential rally or further sell-offs.

The lira meltdown can be halted without recourse to divine intervention only via substantial rate hikes, in whichever shape or form they occur, rather than through a possible but quite unlikely and sudden change in sentiment. The CBRT, however, has shown strong reluctance to deliver any form of hike, and not just now. The benchmark 1-week repo rate has been raised only once since the January 2014 emergency hikes. The same goes for the overnight lending rate. And while the CBRT has been dragging its feet, Turkey’s 12-month average inflation has hovered just below 8% for the past year and half, and above that mark since mid- 2014. This is an ugly performance against the CBRT’s official– and rather unambitious–5% target. Few major EM central banks have done worse over the same period of time.

The currency has already lost 9% vs USD in the first 12 days of 2017, on top of —17% posted last year. Since the end of 2015, TRY is by far the worst performer in the EM FX space (-25% vs USD and —22% vs EUR). All previous record highs for USDTRY and EURTRY have been pulverized in the past two weeks. The two pairs have tested new all-time highs at 3.9415 on 11 January and 4.1785 on 12 January, respectively; levels that could be outdated soon despite the more encouraging start to trading today.

There are numerous reasons for such bad performance, the most compelling of which are: 1) a 15 July coup attempt and related political turmoil; 2) broad-based purges that have followed; 3) a state of emergency rule that has been extended in January for another three months; 4) government-sponsored seizure of companies (in the count of thousands) and assets worth billions of dollars deemed to be linked to Islamic preacher Gulen (by and large considered by the Turkish government the coup’s mastermind); 5) Trump’s election and related risks of more aggressive monetary tightening by the Fed; 6) security issues related to Turkey’s involvement in Syria, and threats from ISIS and homegrown terrorism; 7) plummeting tourism revenues; 8) rising commodity prices, oil in particular; 9) recent lacklustre growth data with Q3 GDP showing the first Y/Y decline since 2009; 10) and, last but not least, CBRT’s progressive loss of independence, and related policy inertia. All this, we think, supports our long-lasting bearish view on Turkey and the lira, which has not changed over the past few weeks.

All this begs the questions if the lira is now cheap and, if the answer to the first question is affirmative, how much more weakness could materialize before TRY can rally?

We believe that the lira has significantly more to sell off if the CBRT does not act decisively. Anything less than a 50-100bps hike next week will not stop the lira plunge. But even with higher rates, we see USDTRY skewed to weakness at around 4.50/4.70 by the end of this year and in 2018, past a temporary phase of lira appreciation.