FxWirePro: No traces of recovery for Turkish lira - Try OTC calls to hedge TRY FX risks

The lira is depreciating steadily once again, and reached a point last week where we should start watching developments closely - after this point, currency weakness will begin to reflect in inflation prints down the road, and this will then feedback to the exchange rate - and that's what the classic lira depreciation spiral, which we have seen time and time again since 2011, is all about. Turkey reported decent industrial output data on Friday but this made no difference to the lira.

For those who may not have followed, Turkstat has revised its manufacturing data, now with 2015 as the base year, and this series shows a faster-manufacturing growth history than the old series showed – this is much like the GDP revision of 2016.

Our skepticism about the new GDP series is well documented and now extend to the manufacturing data to some degree – but, at least the two are consistent now. Coming back to the lira, what could prevent a spiral from taking hold? Either a sharp improvement in global risk appetite or adequate rate hikes by CBT. Which do you think is more likely?

Following consecutive inflation misses, inflation inertia is high with 24-month ahead inflation expectations rising further to 8.6 pct in December from 8.3 pct in November. The current account deficit is running at 6.8 pct of GDP in 3-month momentum measures, with financing likely to be more difficult going forward.

Over the past 12 months, $21bn of the $42bn current account deficit was financed by portfolio flows. Such strong portfolio inflows will be very hard to repeat without a more credible monetary policy backdrop.

Additionally, support from local FX selling has now also waned. After selling $10bn of FX between the end of September and end of October, locals have now switched to FX buying adding $5.5bn to holdings since early November.

As such the 50bps hike, which still keeps real policy rate negative vs. headline inflation at 13% yoy, is clearly insufficient. It is projected that the further sharp FX weakness to force the central bank into a more credible tightening. While we remain UW FX and hold an outright USDTRY ATM +0.51 delta call (spot reference: 3.9475) of 2m2w tenors. You hold this derivative contract on both hedging as well as trading grounds, please observe payoff structure that flies exponentially as the underlying spot FX keeps spiking northwards.

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