As the lira is climbing as a result of the dovish Fed, we see the previous risk of an emergency rate hike decreasing significantly.  

Inflation decelerated to 8.8% y/y in February 2016, down from its 20-month high of 9.6% y/y a month earlier, as the lira weakness effect on prices eased. The Turkish central bank kept its policy rate unchanged at 7.50% in February, in line with our expectations and those of consensus.

We expect the lira to get support in the short and medium term due to improvements in global risk sentiment and rising appetite towards emerging market assets because of the dovish Fed, ECB and Bank of Japan.

Turkey is likely to benefit from improved medium-term policy prospects, eventual resolution of political uncertainties, and greater monetary policy independence compared to its history.

We see a slight deterioration in the TRY spot in the long run, due to rising oil prices and weaker exports, which we believe will add to pressure on the current account deficit.

TRY Hedging drivers:

As crude sensing strength at current WTI prices at $40 a barel, a potential higher oil prices would put renewed pressure on the current account.

Uncertainty about Turkish cross-border military operations, current geopolitical risks and volatile FX inflows could fuel a deterioration in sentiment.

Further dovishness by major central banks is a strong upside risk for our TRY forecasts.

Geopolitical risks could depress the Turkish economy on the back of Russia’s sanctions.

Hedging Strategy of USD/TRY : Diagonal Spread

Hence, go long in 1M ATM -0.49 delta put option while shorting 2W (1.5%) Out of the money put with positive theta or closer to zero for time decay advantage on shorter tenors on short side.

Please observe the payoff table, as USDTRY drifts below spot ref: 2.8647 the strategy constructed above is likely to fetch positive cashflow on expiry, but use tenors as accurately as stated above (the expiries used in diagram are for demonstration purpose only.

If shorting a call in the above strategy at current position is perceived as a risky venture then the zero-cost collar is recommended to participate in the potential bull run on verge of surge in the dollar. This strategy can be executed by buying 1M protective At-The-Money 0.5 delta put option while writing 2W out-of-the-money covered calls with positive theta value.