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The Turkish central bank (CBT) will hold its monetary policy meeting today: we expect the repo rate to be lowered by 150bps (from 14% to 12.5%), which is now also the median consensus forecast. This will bring the benchmark rate down to 12.5%. CBT has already lowered rates from 24% to 14%, so far, this year. This magnitude of easing strongly suggests that the central bank is under pressure to execute President Tayyip Erdogan’s vision of permanently single-digit interest rate in Turkey. Inflation had dropped sharply in Turkey until October because of base effects from last year's lira crisis, but these effects have now begun to fade in November, CPI inflation accelerated from 8.6% to 10.6% again.
Based on the underlying month-on-month rate of price increase, we forecast inflation to gradually accelerate towards c.14% during Q1 next year.
This combination of lower rate and accelerating inflation will reduce Turkey’s real interest rate progressively in coming months, which does not bode well for the lira’s medium-term outlook.
Hence, we remain pessimistic on the lira outlook and project USDTRY to (indicatively) reach 6.60 by the end of H1’2020. Although the major uptrend seems to be little edgy, bulls are hovering at 7-EMAs upon mild overbought pressures after the mild bounce-back from 2-3 months (refer 1st chart). It is a little surprising that EM FX vols have under-reacted so severely to the bearish global impulses that have been in train all year.
Trade tips: Capitalising on any abrupt price dips, we reckon that it is the ideal time for deploying longs with a better entry level. On hedging grounds, USDTRY diagonal debit call spreads are advocated with a view to arrest both upside risks of the major trend and minor dips abruptly. Initiated 3m/1m 5.50/6.25 call spreads at a net debit. Thereby, one achieve hedging objective as the deep in the money call option with a very strong delta will move in tandem with the underlying spikes.
Rationale for the trading: Please observe that the above technical chart is also clearly indicating the further upside risks.
It seems that hedgers of TRY are positioned for the upside risks on the above fundamental factors. The positively skewed IVs of 6m tenors are bidding for OTM calls strikes up to 6.60 levels (refer 2nd exhibit).
IVs of this underlying pair is also on the higher side, trending highest among the G20 FX space. Call options with a higher IVs cost more, because, increasing IV is conducive for the option holder, just for an intuition that the higher likelihood of the market ‘swinging’ in holder’s favour. Courtesy: Commerzbank & Sentrix
