FxWirePro: Turkish lira on a bullish rout on spike in swap rates

The lira rallied strongly yesterday as the cost of short lira positions surged to its highest ever via a sharp spike in lira swap rates. Media commentary suggested that this was engineered by local banks stopping not wanting to lend any liras to counterparties, which made the price of liras skyrocket. The increase in swap rates was far greater than the limited 150bp by which CBT had officially hiked its funding rate for banks. Hence, some form of 'quantitative restriction' or capital control indeed appears to be the culprit. 

We do not pretend to have any inside track on whether or not the government or central bank have instructed banks to stop lending liras and over what timeframe but this opens a very interesting chapter in the lira's development what economists call a 'natural experiment' in the real-life economy. 

We are strongly of the belief that 'speculation' against the lira and the demand/supply of dollars in the market are not underlying causes of the lira's longer-term depreciation trend -- these are just symptoms, instruments of how the market mechanism has to proceed. The underlying cause has everything to do with Turkey's macroeconomic imbalances, persistently high inflation, and the reluctance of the central bank to hike rates further, quickly if required. Trying to trace the impact of these broader imbalances to the precise market instruments which will materialize the exchange rate result is both unwise and a waste of time. If we are right, then beyond an initial reaction, these types of interventions will fail to stem lira weakness. 

Unless of course, the intervention is a proper, sustained capital control -- capital controls, if implemented, will of course have a definitive impact on the exchange rate -- no question -- but in that case, policymakers will have to make it clear that they have done so and will have to accept the dampening consequences via foreign capital inflow and economic growth. But this very low-growth scenario was becoming unbearable for the government. Courtesy: Commerzbank

Currency Strength Index: FxWirePro's hourly USD spot index was at 78 (bullish) while articulating (at 13:01 GMT).

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