CBT holds its March rate in the recent meeting: we do not expect the Turkish CB to raise its benchmark repo rate from 8%. CBT is unlikely to touch any other rate either, besides the late liquidity lending rate, which we expect CBT will hike by 100bps to 12%. No other significant monetary tightening is likely this month because the Turkish constitutional referendum will be held next month – the political atmosphere is tense, and AKP heavyweights will be prone to classifying people readily as 'friend' or 'foe' depending on their actions; prominent rate hikes now would almost certainly be viewed as an act of sabotage. 

Crucially, the USD itself has retreated following recent Fed rate hike that has triggered a sharp EM rally; the lira, which was beginning to show signs of strain in the lead up to the FOMC decision, is enjoying some relief and does not need emergency support from CBT right now.

Over coming months, however, CBT would have to consider raising the overnight lending rate, if not the repo rate itself, in order to better stabilise the lira in an environment of steadily higher DM interest rates. The money market operations currently being used on a daily basis disrupt the normal liquidity management of banks, with funding being provided almost exclusively from the late liquidity window at 11%. This is evident from the rise in the weighted average funding cost for banks to 10.8% which is not far away from the peak 11%.

At some point, CBT will have to acknowledge that the lira problem is not temporary and that banks need to be allowed to return to normal functioning, which means funding using normal liquidity channels – but before this can be done, the normal lending channels will have to charge higher interest rates. We see USDTRY rising to 3.90 by the end of the year assuming that CBT will keep effective interest rates in the 11% region.   

Hedging Framework:

Capitalizing on prevailing dips of this pair one can load up shorts in ITM calls and longs in either ATM or OTM calls in a credit call spread with a narrowed strikes and tenors on the short leg.

While major uptrend could be arrested by the longs of the underlying pair with longer tenors.

So it is advisable to initiate Diagonal Credit Call Spread (DCCS) in order to tackle both short-term dips and major uptrend.