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In today’s MPC meeting of the Central Bank of the Republic of Turkey (CBRT), we reckon that the central bank would now want to guide a message that it seems credible on fighting inflation, discourage ongoing market speculation against the currency, while simultaneously building in a buffer of policy space to be deployed in the future.
Hence, we believe that there may be a divergence between the envisioned hikes in the late liquidity window (LLW) lending rate (in theory, an emergency facility) versus the hike in the effective funding rate (i.e. the weighted average cost of funding).
On the flipside, this morning has been unsurprised one with the Fed decision and the market response; indeed, the US central bank has raised funds rate by 25 bps to keep it at 1.50% as widely anticipated.
The policymakers’ median forecast is now fully aligned with our call that there would be three further hikes in 2018, followed by another two in 2019. We don’t expect the Fed to change its tone or direction appreciably under the incoming Chair Powell.
FX options trade:
In outright trades, we recommend buying a 2m USDTRY vanilla call.
The options market has so far priced in only a moderate deterioration in the outlook for lira with close to average levels of implied volatility and skew.
However, as we are in our view now transitioning towards our “bear case” scenario of an increasingly negative feedback loop between the currency, asset prices, and outflows, we can envisage a much more fragile pattern before the central bank is forced to step-in in a credible manner.
The situation is likely to be exacerbated by negative current account seasonality in December and low liquidity around the year-end.
We, therefore, recommend buying a 2m USDTRY ATM +0.65 delta call indicatively priced at 1.26% (spot ref. 3.8248) to take advantage of the likely rise in volatility and skew as USDTRY trades higher. The risk on the trade is limited to the premium paid.
One could this utilize this as the speculative instrument as well, if you look at the payoff structure, one can achieve positive cashflows as the underlying spot FX keeps going upwards.
