For investors expecting the one-directional play of the US dollar to dominate this morning’s trading session, it’s a rude awakening: the greenback dropped from a multi-year high versus the yen after reports emerged the U.S. president is concerned about the dollar’s strength.
In the overnight session, a fall in Chinese import data, and stronger growth numbers from Japan have also helped make Monday an eventful trading session, especially after last Friday’s stellar nonfarm payrolls report. For most speculators, capital markets are certainly living up to central bankers’ current fears – heightened volatility — be it because of rate moves or fluctuations in currency prices.
Aside from the ongoing potential Grexit concerns, the euro investor’s confidence has again been rocked with the weekend’s election outcome in Turkey. The country’s ruling party lost its majority in parliament yesterday, sending Turkish assets and the lira (TRY) plummeting to new record lows ($2.8096). For the first time in a dozen years, President Recep Tayyip Erodgan’s Justice and Development Party (AKP) is unable to form a majority government. Currently, the AKP is on track to win approximately +41% of the vote, falling about 18 seats short of a parliamentary majority. Investors despise uncertainty, and the market’s reaction to a potential “hung” government will always be a domestic asset selloff – equities lower, rates back up, and currency underperforms.
The CBRT Had to Act
Some investors fear that future political infighting will only destabilize the country, making it a rather unattractive investment opportunity for capital markets. Over the past five years, Turkey has been experiencing a period of relative economic stability with steady growth. Yesterday’s election results could potentially bring this period of sound economic management to an end.
Some individuals would consider Sunday’s election results as an outright blessing despite equities and bonds plummeting this morning. A number of political pundits feared that an AKP majority would have put Turkish constitutional change back on the agenda, keeping Erodgan’s goal of a presidential republic on course, in turn having a material impact on Turkey’s economy. The “Erdonomics” witnessed by capital markets this year have done little to garner market stability. In fact, political shenanigans have been pressuring the TRY to trade at or near its record lows against the dollar, and to a lesser extent against the EUR (€3.1142). Obviously, the record TRY moves have been making the Central Bank of the Republic of Turkey’s (CBRT) job much more difficult.
Will Turkey’s Central Bank Hike Rates?
With Turkey losing investor confidence, which will only have a negative impact on Turkish assets, the market will be looking to the CBRT to restore confidence.
Up until now, policymakers have been attempting to provide some TRY support by cutting deposit rates on foreign currency deposits (decreasing USD and EUR deposit rates by -50 basis points). However, this has had a minimal lasting impact as it’s not perceived by the market as having the same credibility as an actual rate hike. The TRY bear will continue to look to Turkey’s large current account deficit, the volatility in the global bond market, and the Federal Reserve’s potential rate divergence argument for reasons to remain underweighted the lira outright and across the majors.
The CBRT, like most other central banks, have been following an easing policy. In light of current events, Turkish policymakers may have to reverse course on their interest rate policy and actually “hike” overnight rates to support the floundering currency, at least until political clarity emerges.
TRY bears will have to remain wary of a backlash, especially when a coalition government is formed, and if the constitutional “presidential system” is taken off the political agenda. For now, the immediate event risk for the TRY remains the next CBRT move. It will be expected to tighten lira liquidity over the coming days, but will that be enough to ease market volatility, and give the TRY some much needed support?
