FxWirePro: Turkish lira responds to CBRT despite apprehensions of President Erdogan – Stay away from longs but uphold long hedge

The lira surged back nicely yesterday after the central bank hiked rates sharply (by 625bps to 24%). The central bank strongly asserted its independence despite President Recep Tayyip Erdogan criticising the bank again and demanding lower interest rates – this was a positive signal from the central bank. 

What is unclear, however, is whether there will be a political fallout from this assertion of independence or whether CBT has received 'limited approval' from political leaders. 

In any case, we forecast inflation to soon outstrip even the 24% interest rate – hence, it all depends on whether CBT will change its style to more pro-active in future and keep the real interest rate positive. We are cautiously optimistic, but we still do not forecast a trend appreciation of the lira. 

Stay underweight in TRY despite technical measures to support the currency: We reckon that a major source of concern is now the debt burden of the economy and the rising external rollover needs over September and October. A credible package is required to secure external funding needs, which would involve central bank hikes, government support for banks and resolution for NPLs in the corporate sector, as well as a recognition that the economy needs to go through a period of managed deleveraging. 

On all of these fronts, there has been only modest progress so far. The central bank signalled its intention to tighten policy at its upcoming meeting, and our economist now forecasts a 250bps hike both in September and October. 

However, only 250bps tightening at the next meeting would lead to a disappointment, in our view. The medium-term fiscal plan is likely towards end of September; however, with TRY10bn loan support announced to SMEs recently, it is unclear if it will go far enough in facilitating ordinary deleveraging. Taking into account poor policy track record, we recommend staying UW but some hedging strategy is also advocated.

As long as these external financing needs exist and the central bank does not offer attractive real interest rates the TRY crisis will not have been overcome on a sustainable basis so that the depreciation pressure on TRY will continue. Courtesy: JPM

At spot reference: 6.1296 levels, contemplating above driving factors, on hedging grounds we advocate buying 3m (1%) ITM USDTRY call option, deep in the money call with a very strong delta will move in tandem with the underlying spot FX.

Currency Strength Index: FxWirePro's hourly USD spot index has shown -32 (which is bearish), while articulating at 13:41 GMT. 

For more details on the index, please refer below weblink: 

http://www.fxwirepro.com/currencyindex