FxWirePro: CBRT maintains status quo - Alluring TRY valuations in yield-hunting and hedging setup

The Central Bank of Turkey held its benchmark one-week repo rate at 8 pct today as widely expected. Policymakers said the economic recovery has gained strength boosted by domestic and external demand from the EU countries while high inflation continues to pose risks. As a result, a tight stance in monetary policy will be maintained until the inflation outlook improves significantly.

Against a favorable backdrop for continued yield-seeking behavior, TRY looks attractive for its cheap valuations (16% under-valued versus 10-yr REER average), CBRT’s commendable shift toward tight monetary policy and prioritization of financial stability, and the country’s diminished risk of political upheaval. November 2019 general elections provide motivation for officials to bolster economic momentum while keeping the currency stable.

Key drivers: Perpetuation of suppressed reflationary risks in developed markets support TRY as a high-yielding EM currency. A clear decline in locals’ appetite for accumulating FX deposits (some timid initial signs have appeared) could spark the next leg of the TRY rally. 

Risks: Due to elevated external vulnerabilities (e.g. high external debt to GDP, the high proportion of short-term liabilities, current account deficit), Turkish assets are susceptible to selloffs in developed market assets such as US Treasuries. Lapses in the tightness of CBRT liquidity policy could undermine the central bank’s new-found and still-tentative policy credibility.

The conservative hedgers of USDTRY can prefer the below strategy:

Debit Put Spread = Go long 1M ATM -0.49 delta Put + Short (1%) OTM Put with lower Strike Price of similar tenor with net delta should be at -0.14.

For a net debit bear put spread reduces the cost of trade by the premium collected (on the shorts of OTM put) and keeps option trader to participate in downward moves and any upswings in abrupt.

Moreover, the risk is capped to the extent of initial premium paid, as opposed to unlimited risk when short selling the underlying outright.

However, put options have a limited lifespan. If the underlying FX price does not move below the strike price before the option expiration date, the put option will expire worthless.

Alternatively, aggressive bears can bid USDTRY 1% OTM strikes of naked put with mid-month tenors.