A month ago I asked “how long can a parabolic Turkish lira last?” The answer turned out to be a month. However, the path to the end included two false conclusions and a massive blow-off top. The trading in the Turkish lira (USD/TRY) provided a new lesson in parabolic price action. Parabolic trading is inherently unstable. Either the market participants driving the move eventually exhaust themselves and/or a force emerges to counteract the catalyst behind the parabolic firepower. In the case of the lira, the Turkish government provided the countering force. In a move that will likely prove costly over time, Turkish President Recep Tayyip Erdoğan issued a guarantee to bank depositors to protect them against exchange rate risk.
Erdogan announced to Turkish depositors that the Treasury will cover the difference between the interest they earn on deposits and the rate of currency depreciation. This news caused a rush of lira inflows for banks. According to Reuters, depositors “converted up to $1.5 billion in savings on Monday night alone.” This flood of exchange placed dramatic pressure on USD/TRY. In just over two hours alone, USD/TRY fell 28%. USD/TRY collapsed a total of 40% from its intraday high to the close on the week.
The Mother of All Guarantees
On Tuesday, the Central Bank of the Republic of Turkey (CBRT) provided some specifics of the exchange rate guarantee. Here are some key highlights:
“The interest/profit share that will be paid to TL time deposit accounts/participation funds to be opened and the difference in exchange rates at the beginning and at end of the maturity will be compared, and the deposit and participation fund holder will be paid whichever is higher. Regardless of the exchange rate on the day the account is opened and the exchange rate at the end of the maturity, the principal and the interest/profit share will be paid to the client by the bank. If the amount to be calculated using the exchange rate applicable at the end of the maturity is greater than the sum of the principal and the interest/profit share, the difference will be covered by the CBRT.”
The policy begs the question: how will the CBRT pay for the guarantee? Surely no insurance company will offer coverage. Instead, the Treasury will likely issue debt to cover payments for currency exchange losses. Once the debt grows large enough, the government will be forced to monetize the debt (print money). Once the printing press gets going, the Turkish lira will face fresh deflationary pressures. Currency traders are sure to test this self-reinforcing dynamic some time after the dust settles. At that point the massive transfers should subside to a modest equilibrium. In other words, Turkey likely remains locked in an inflationary spiral.
The Trade
I closed out my fade on EUR/TRY (the euro versus the lira) shortly after I posted my last Turkish lira article (I placed a comment on that piece). EUR/TRY dropped about 5% and provided sufficient profit for such a risky trade. Soon after that, traders resumed betting on another rate cut from the CBRT. The subsequent rally technically only went parabolic after the CBRT once again bowed to political pressure and cut its main rate from 15% to 14%. Per my preference to fade extremes in financial markets, I accumulated a fresh position short EUR/TRY. Still, I could not anticipate the explosive drama from this new lesson in parabolic price action.
Given all the losses the lira suffered from past rate cuts, I am guessing the parabolic revolt struck a catalyzing fear in the government. Once I absorbed the significance of the news, I closed out my position. The steepness of the plunge felt like a gift, and I did not want to succumb to greed. I simply have little concept of how a depositor bumrush back into a home currency might play out!
For now, I am content to watch the dust settle before deciding on my next trades. The 50-day moving average (DMA) (the red line above) is currently acting like a pivot for USD/TRY. However, I assume the bias remains down until USD/TRY buyers successfully close out USD/TRY above the 50DMA and create additional upside pressure from there.
Be careful out there!
Full disclosure: long BTC/USD