Turkey May Face ‘Nightmare’ After Wild Lira Rally

“Who were these buyers?”, wondered Nureddin Nebati, Turkey’s recently installed Treasury and Finance Minister, during remarks to NTV.

He was referring to recent purchases of foreign currencies amid a collapse in the lira brought about by four consecutive rate cuts from the country’s beholden central bank.

“Surely, not big financiers. Any financier in his right mind would know things would revert some way in Turkey,” Nebati went on to say, before posing another question: “So, who got burned?” And then answering himself: “Small investors, as always. Now they are brooding over their losses.”

Maybe. Or maybe they’re “brooding” over the fact that thanks to Recep Tayyip Erdogan’s decision to take Erdoganomics to its (il)logical extreme, the lira is behaving more like Bitcoin or a meme stock than a currency issued by one of the world’s most important emerging markets.

This was easily the most absurd week in recent history for the lira. And that’s really saying something.

As dramatic as it is, the figure (above) still feels somehow insufficient. Three-month implied vol blew past levels seen during 2018’s mini-crisis.

It’s very difficult to find the right adjective, let alone the right visual, to capture the lunacy inherent in a sovereign currency swinging by 30% in a single day, which is what the lira did Monday, following Erdogan’s big unveil of a deposit guarantee scheme aimed at averting a banking collapse, which looked imminent.

In “Desperate Times: Erdogan’s Scheme To Avert A Bank Run,” I talked a bit about what the plan actually means, and how it could backfire. In a note dated Friday, TD’s Cristian Maggio warned of a potential “Nightmare After Christmas” for Turkey. It’s possible, Maggio said, that the lira’s rally was due in no small part to state intervention in an illiquid market, rather than to a sudden restoration of confidence in lira deposits.

“We still lack evidence that investors (especially locals) have turned en masse to converting hard currency into lira,” he wrote, adding that “the latest information on reserve usage provides strong evidence that the CBT has used the big guns, through both direct intervention and its swap program.”

According to sources who spoke to Bloomberg, the lira’s Monday rally (which reached 25% at one juncture), “was supported by state banks [and] at least one private lender.” The sales continued on Tuesday, the people said. Turkey’s net foreign assets dropped from $817 million to negative $5 billion over those two days (figure below).

CBT has announced multiple direct interventions this month, but none this week. The Financial Times cited a former central bank official who said Monday’s rally was in fact due “a least in part” to “backdoor intervention.” Another analyst cited in the same linked FT article suggested such interventions may have been as high as $7 billion.

Meanwhile, Turkish stocks are in a tailspin, Friday’s rally notwithstanding. Over the past week, circuit breakers on the Borsa Istanbul have been tripped multiple times, and the index plunged into a bear market over the space of just a few sessions, leaving market watchers to ask whether the move was a reversal of demand for equities as an inflation hedge or just a wholesale abandonment amid confusion and panic. (It’s probably both.)

Margin calls exacerbated the situation (figure above).

Commenting further on Friday, TD’s Maggio noted that although the fall in Turkey’s gross reserves is “immediately visible to all,” the jump in swaps isn’t. The central bank’s program hit record highs this month (figure on the left, below).

On an adjusted basis, net reserves are sitting at a new record low. “Under these conditions, Turkeys macrofinancial stability looks unsustainable,” Maggio remarked, adding that in TD’s view, it’s possible the lira could come under renewed pressure soon.

Erdogan doesn’t agree. “We are battling against the oppression of our people with inflation and interest,” he declared, earlier this week. “This time, we will achieve the results we want.”

On Friday, he said the lira would “find its level” in the free market. Speculators in FX will “face legal action,” he warned.