Lira Becomes Currency to Short as Erdogan Fuels Rate-Cut Fears

(Bloomberg) --

Lira watchers are back to bracing for currency turbulence as President Recep Tayyip Erdogan’s latest round of dismissals at the Turkish central bank bolsters expectations of another interest-rate cut next week.

The lira slumped to unprecedented levels after Erdogan fired three monetary policy makers who were wary of reducing interest rates further. Options traders see a more than 50% chance that the currency will weaken to 9.5 per dollar in a month, after it slid to a record low of 9.1883 on Thursday. 

The risk of a rate cut on Oct. 21 threatens to push Turkey’s real rate deeper into negative territory, at a time when other central banks in developing economies are tightening policy to rein in inflation. The currency became the biggest loser in emerging markets this year after the central bank unexpectedly reduced its benchmark in September, despite a deteriorating inflation outlook. 

“Turkey goes from crisis to crisis,” said Cristian Maggio, head of portfolio strategy at TD Securities in London. “And these are mostly of a political nature, so I let you imagine why this coming one is not the last and what it takes to halt this dreadful cycle that repeats every few quarters.”

The lira will probably hit a low of 9.75 per dollar next year, Maggio said, adding that “these are only indicative levels that express a direction of travel.”  

The currency’s weakness will likely add to inflationary pressures building in the economy as energy prices climb. Foreign investors sold a net $673 million of Turkish stocks and bonds in the past two weeks, figures from the central bank show.

“Today’s announcement only adds to the lira’s woes as the first step toward policy easing has already begun,” said Ima Sammani, an analyst at Monex Europe. “In some of the previous sacking cycles, however, the lira was mildly supported by a more prudent and predictable monetary policy stance.”

Stock investors appeared to shrug off the central-bank ructions Thursday, with the benchmark Borsa Istanbul 100 Index climbing 0.4% as of 11:44 a.m. local time. Turkish stocks trade at a near-record valuation discount compared with their emerging-market peers, supporting sentiment. 

Here’s a roundup of comments on the outlook for the lira and monetary policy:

Piotr Matys, a senior currency analyst at InTouch Capital in London:

• The CBRT is likely to cut rates again next week
• “This will have negative inflationary consequences due to an even weaker lira, which will also keep the process of dollarization intact”
• “It may also cause a full-scale crisis as even the relatively flexible Turkish economy has its limits in absorbing currency shocks”

Jason Tuvey, senior emerging-markets economist at Capital Economics:

• “The backdrop of political pressures and sharp falls in inflation over the next six months or so mean that we think the one-week repo rate will be lowered by a further 600 basis points to 12%, by the middle of next year -- a matter of what the MPC is likely to do rather than what it should do”
• “But with the economy already operating above its pre-virus trend, that risks sowing the seeds of another balance-of-payments crisis”

Henrik Gullberg, macro strategist at Coex Partners:

• “Markets will now definitely expect further easing at the Oct. 21 meeting, despite the weak lira and the risk of further depreciation when that happens. Like we know, this follows an old pattern”
• “In the past, only a depreciation sufficient to hurt Turkish companies enough for them to voice their concerns to Erdogan has resulted in Erdogan and the CBRT abandoning their plans to reduce rates no matter what and reverse course. But obviously we are not there yet”

Hasnain Malik, Tellimer, Dubai-based head of research at Tellimer Research:

• “There is no doubt that President Erdogan is the most important voice on interest rate policy and these changes at the Monetary Policy Committee confirm that”
• “There is also no doubt that he believes rates should be cut in times of high inflation. Every time investors hope that belief is fading, they get a painful reminder”

Saed Abukarsh, chief investment officer at Ark Capital Management in Dubai:

• “The central bank will have a very hard road to establish credibility now that it appears that the central bank is politically motivated in its policy”
• “Expect further losses in lira and lira-denominated assets”

Ehsan Khoman, head of emerging market research for Europe, Middle East and Africa at MUFG Bank in Dubai:

• “The current modus operandi at the CBRT supports further easing, with our base case for 100 basis points in cuts” on Oct. 21

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