Perhaps President Recep Tayyip Erdogan was right all along? It seems rate cuts are exactly what Turkey needs.
As global central banks pedal backward on monetary policy, the Central Bank of the Republic of Turkey (CBRT) stands out with its extremely high rates. The CBRT got here as part of a fight against persistent and worsening inflation. Now, with disinflation supposedly underway and a new head of the CBRT in place reportedly more closely aligned with the President, the path of least resistance is downward for rates. Given the response to last week’s huge 425 basis rate cut which sent the one-week repo auction rate to 19.75%, it seems I was wrong to conclude that the new governor, Murat Uysal, would trigger fresh weakness in the Turkish lira.
The Rate Cut
The Turkish lira initially weakened as I would expect after a rate cut, especially one so large. The buyers stepped in after USD/TRY hit the top of the recent range (and now close to a declining 50-day moving average (DMA), and they have yet to stop applying downward pressure to USD/TRY.
I can only assume that traders picked up on the disinflationary message in the CBRT’s press release on monetary policy (emphasis mine):
“Inflation outlook continued to improve. In the second quarter, inflation displayed a significant fall with the contribution from a deceleration in unprocessed food and energy prices. Domestic demand conditions and the tight monetary policy continue to support disinflation. Underlying trend indicators, supply side factors, and import prices lead to an improvement in the inflation outlook. In light of these developments, recent forecast revisions suggest that inflation is likely to materialize slightly below the projections of the April Inflation Report by the end of the year.”
If this revision in the inflation forecast holds, a peak in inflation for Turkey may have finally arrived. The CBRT suggests in its actions and words that it will follow lower inflation expectations with lower rates. As long as these factors accompany an improving economy, then the Turkish lira should continue to strengthen and reverse some amount of its weakness over recent months. The monthly chart below demonstrates just how weak the lira has become over recent years.
The CBRT had encouraging things to say about the current economy in Turkey. While an improving economy conventionally attracts prospects for higher rates, Turkey’s case is reversed because disinflation is part of the narrative of a strengthening economy. From the CBRT (emphases mine):
“Recently released data indicate a moderate recovery in the economic activity. Goods and services exports continue to display an upward trend despite the weakening in the global economic outlook, indicating improved competitiveness. In particular, strong tourism revenues support the economic activity through direct and indirect channels. Looking forward, net exports are expected to contribute to the economic growth and the gradual recovery is likely to continue with the help of the disinflation trend and the partial improvement in financial conditions…Current account balance is expected to maintain its improving trend.
Turkey’s burdensome account balance was a major part of the bear case on the Turkish lira. It looks like that weight is also lifting.
While I was fortunate to short EUR/TRY around the CBRT announcement, I continued to hold my core long USD/TRY position. I plan to hold until/unless it breaks below support at its 200DMA. Of course, rate cuts and dovish policy statements from the U.S. Federal Reserve could provide sufficient catalyst to break USD/TRY down further; I will be careful to wait out any resulting near-term volatility. EUR/TRY sliced through its 200DMA at the beginning of this week, so I am actively looking for entries for new short positions. I
If all goes well, I will be transitioning from a net short lira position to a net long one. I will use the 200DMAs as key pivot points. This transition will be a clear break from the strategy I had in place to take advantage of the periodic run-ups against the Turkish lira.
Be careful out there!
Full disclosure: long USD/TRY