When the president says that the policy of interest rate cuts leads to a slowdown in inflation, it seems to be a lie. In fact, structural problems are worsening in Turkey, making a continuation of the USDTRY rally inevitable. Let’s talk about this topic and draw up a trading plan.
Quarterly fundamental lira forecast
What scares investors more, the war in Ukraine or the presidential elections in Turkey on May 14? Judging by the fact that the cost of hedging against the lira drop exceeded the cost of hedging against the risks of the Russian ruble weakening, political uncertainty is worse than geopolitics. The USDTRY has been trading flat over the past few months, and it could turn into one of the most volatile Forex pairs. The options market bets on a 60% chance that the USDTRY will reach a level of 25.
According to the Eurasia Group, Recep Tayyip Erdoğan has a high chance to win the presidential election in Turkey. The chance rose from 55% to 60% amid the opposition’s inability to compete with the current president. Moreover, the president’s formally paradoxical theory is bearing fruit. While the world’s central banks are fighting inflation by raising rates, the Central Bank of the Republic of Turkey (CBRT) is lowering borrowing costs. Thus, from August to November, the official borrowing cost in Turkey was cut by 500 basis points, and inflation slowed down from its peak value of 85% to 57.7% in January.
Turkish inflation and CBRT interest rates
Source: Trading Economics.
In fact, the sharp cooling in consumer prices is based on declining energy prices around the world, fixing problems with supply chains, a long period of lira stabilization, and, most importantly, statistical discrepancies. In 2022, inflation accelerated sharply, and now, compared to the previous values, price growth outwardly looks slower. However, on a monthly basis, the CPI jumped by 6.7%, the fastest pace since April.
I can’t but mention the titanic efforts of the Turkish government to support the lira. In 2022, $108 billion was spent on foreign exchange interventions, which, by the way, did not save the lira from more than a 30% loss of its value. It is the worst performance in Forex after the Argentine peso.
In addition, Ankara uses alternative instruments, such as a guarantee that the value of deposits in national currency will be preserved even if USDTRY grows; there are benefits for exporters when converting foreign currency if they then undertake not to make reverse transactions; there are restrictions on the sale of derivatives and many other measures. Formally, these factors prevent the lira from weakening. However, if one looks deeper, the above measure can speed up the currency crash in the future. In particular, against the backdrop of rising deposit rates above 25%, there is an outflow of capital from the Turkish stock market, which creates problems for stock indices and encourages foreign investors to withdraw their money from Turkish markets.
Dynamics of deposit rates in Turkey
Source: Bloomberg.
Quarterly USDTRY trading plan
TD Securities believes that multiple structural problems in the economy make further lira crash inevitable. JP Morgan and Goldman Sachs argue that correcting the imbalance requires raising the main interest rate to 30%, more than three times above the current level. It is unlikely that all this will happen, so the USDTRY rally will continue towards at least the previously indicated target at 19.1. the trading recommendation is to buy.
Price chart of USDTRY in real time mode
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