FxWirePro: Turkish Lira Signals Further Depreciation Pressures – FxWirePro’s USD/TRY ‘Debit Call Spread’ Delivers As Desired

The Turkish lira continued to sell-off towards the latter part of last week, although the momentum eased off as the weekend drew near. CBT and the banks regulator BDDK often make policy announcements such as RRR change or change to exposure limits during a weekend, hence it is natural that market participants lightened their positions ahead of one. In general, the policy response so far is playing out as we had anticipated – there are ad hoc interventions and restrictions on trading and market access in an attempt to stamp out short lira positions. To begin with, the central bank has reduced the open market operation liquidity limits for primary dealers by half – these had been increased in March as part of the pandemic response – reducing it will slightly raise CBT’s weighted average cost of funding (currently below the 8.25% policy rate at around 7.8%). BDDK has also promised to revise its asset rule which it has used recently to fine banks.

The general tone of policymakers appears to be to roll back some of the liquidity boosting measures which had been implemented as part of corona response in order to prompt banks to lend more to the real sector. The implication is that the excess liquidity created by those measures is no longer required, hence are now pressuring the exchange rate.

In this way, the underlying issues will continue to be sidestepped. Unless pressure on the exchange rate were to really mount, sending USDTRY to levels such as 8.50, we would not anticipate a more meaningful policy re-think.

As we have written repeatedly, no cocktail of these banking system tinkering or partial capital control measures is capable of turning the lira trend around. Harsher capital controls can buy some more time, perhaps. But, the underlying weakness arises out of an inconsistent monetary policy framework, featuring no inflation targeting – and this will continue to build up stress in the background until it ultimately forces fundamental change.

Trade tips:

On hedging grounds, with a view to arresting momentary downside risks and upside risks in the major trend we already advocated 2m USDTRY debit call spreads when it was trading at 6.7940 levels. Now, the spot reference is 7.3175 level, initiated 2m 6.25/7.20 call spreads at net debit. The strategy has achieved hedging objective as the deep in the money call option with a very strong delta moved in tandem with the underlying spikes.

It seems that hedgers of USDTRY are positioned for the upside risks on the above fundamental factors. Hence, we wish to uphold only the long leg for now.

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: Sentry & Commerzbank

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