FxWirePro: Is Turkish economy contracted? TRY trade perspectives

The Turkish economy contracted by a sharper-than-expected 1.1% quarter-on-quarter in Q3 and we expect further mild contraction in Q4. The behaviour of key expenditure components was more or less in line with expectations during Q3, with private demand imploding, but being countered by a jump in net-exports. To us, the main surprise was the contraction in government expenditure – which suggests that the change-over to the presidential system occupied political leaders during the time and no coordinated stimulus package could be implemented. This can change. And amidst that, the pressure on CBT to lower rates is likely to increase. 

What will CBT do? 

This brings us to the main risk factor: as these economic performance numbers affect AKP’s political standing, and policymakers scramble to find stimulus measures, what could we expect from the central bank? FinMin Berat Albayrak already promises lower interest rates in coming months. True, he refers more to pressuring banks to reduce their margins on loans – but, such reduction will have natural limits because bank profitability is anyway likely to be squeezed by rising FX liabilities (result of weaker lira). 

CBT promises a ‘tight stance’ going forward. But we know that this has no specific meaning – the CB can call its stance tight when the real interest rate is +200bps, and it can call it tight when the real interest rate is -200bps. Especially as inflation is now moderating, the pressure on CBT to lower the nominal policy rate will be high over the coming quarter. As a base-case, we assume that CBT will only lower rates by a margin which will maintain a mildly positive real interest rate, but not a significantly positive one. In this case, the possibility of a calculation error – i.e. inflation somehow accelerates again after CBT has already lowered rates – remains high. This is the key risk for lira investors. 

Conclusion 

In summary, the real economy is contracting but could stabilise quarter-on-quarter in the next two quarters. 2019 is still likely to record slower than 1% growth. As far as the lira is concerned, USDTRY has declined sharply over the past couple of months, but the risk lies to the upside if the government feels pressure to find stimulus measures to fight the recession. Trade tips: We forecast USDTRY to rise back to 4.9740 levels later during 2019. 

At spot reference: 5.3294 levels, contemplating above driving factors, on hedging grounds we initiate RV trade - 3m USDTRY put up-and-in Short 1m put. Courtesy: JPM, Commerzbank

Currency Strength Index: FxWirePro's hourly USD spot index is flashing 72 (which is bullish), while articulating (at 14:43 GMT).

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