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The political risk is going to take center stage. The US election presents a major risk for the FX market in the event of a Trump victory that would imply it is high time to look at the question of what an election victory for Donald Trump would mean for the US currency.
His policies could differ fundamentally from that of previous administrations – unless everything we have heard from him so far were simply empty phrases. A Trump victory, therefore, has the potential to be of relevance for USD exchange rates.
The lira gained vigorously today as CPI data surprised to the downside: prices rose by 1.4% MoM vs. market expectation of 1.7% increase. The year-on-year inflation rate fell to 7.2% YoY in headline terms and 7% in core terms.
However, our calculations show that the commodity and oil prices are becoming increasingly positive year-on-year, especially as the lira has been weakening recently – this means that the room for further inflation moderation is limited.
We forecast 6.6% average inflation for 2017. The risk now is that, based on this good inflation data, government pressure on CBT to lower rates will mount, resulting in excessive monetary easing just at the wrong time.
Option trading strategy:
The USDTRY has hit to all-time highs as expected in our recent post and is an appealing options hedge against a Trump victory as further upside risks are foreseen.
We had advocated call spreads to arrest bullish risks, we still maintain bullish portfolio with slight modifications in tenors and strikes, add longs in 2m USDTRY call strike 3.17, knock-out at 3.30 (link):
ATM volatility returned to the non-distressed region (below 12), while topside exposure can be advantageously cheapened.
Among EM FX volatility smiles, USDTRY 3m risk reversal is one of the highest compared with 3m ATM volatility, suggesting dollar calls that sell topside skew.
Abstracting from the US elections, the trade is appealing for USD bulls given that the TRY remains on a downward track, compared to other currencies in the region that are closer to their strongest levels this year (i.e. ZAR and RUB).
