The Turkish lira is fluctuating wildly. We break down the forces behind the rough seas
1 TRY’s recent performance
The USD/TRY, which was at 3.77 at the beginning of the year, stayed in the 3.70-3.80 band until early March but then began to depreciate rapidly after March 12, reaching a record low of 3.95 against the dollar on March 20. The depreciation of the TRY against the dollar since the beginning of the year has exceeded 5 percent, ranking it second amongst the losers among developing country currencies, after the Argentine Peso. The TRY rebounded somewhat on March 20 after the bond auctions and announcements by the Fed but then depreciated sharply on March 23 because of Japan. With the Japanese yen appreciating rapidly, many carry trade positions deteriorated and this caused USD/TRY to rise to 4.03 in the shallow market.
2 International conditions
The expectation that the Fed will raise interest rates four times this year, which emerged after the presentation of Jerome Powell, the Fed’s new president, at the U.S. congress on February 27, led to the dollar’s appreciation against other currencies. This led to a general anxiety over risk. However, on the evening of March 21, the FOMC members’ expectation for a rate increase for 3 times reduced concerns related to the Fed.
3 The course of interest rates
Treasury’s borrowing cost has risen rapidly in recent months. In March, the benchmark 2- and 10-year yields rose by nearly 100 basis points to 13.98 percent and 12.92 percent, respectively. The average return at the treasury tender on March 20 was 13.98 percent for the two-year treasury bill and 12.83 percent for the 10-year treasury bill. The rate for the 10-year bond reached its historic record level. The expectations for fund inflows were positively affected by the high demand, which was 5.3 times the sales amount to the tenders despite the high interest rates. This led to a slight lapse in the pressure on the exchange rate.
4 High inflation
Inflation in Turkey is at 10.26 percent as of February. This rate represents a decrease from the peak at 12.98 percent in November last year. However, this decline is more moderate than predicted and was mostly due to the base effect. On the other hand, the depreciation of the TRY is expected to create upward pressure in the coming months. Moreover, the PPI, which rose to 13.7 percent in February from 12.1 percent in January, indicates that cost-driven inflationary pressures continue. This rigidity seen in inflation also affects expectations for the future, leading to pressure on the currency.
5 Geopolitical risks
Although Turkey’s Afrin operation is approaching an end relatively quickly and without a problem, the possibility of starting new operations in the region is causing concerns among inves- tors. Any new operations threaten to put Turkey in conflict with United States or Russia. The expectation that the policies of Trump’s new Secretary of State and security advisor will not be compatible with Turkey also raise tensions.
6 Increasing current account deficit
Turkey’s current account deficit has increased rapidly due to the overheating of the economy in recent months and the mobility in commodity prices. The annualized current account deficit rose from $36 billion in September to $52 billion in January. The CADto-GDP ratio has reached risky levels at 5.5 percent. The financing need created by this deficit creates an extra pressure on the economy in an environment where the interest rates are rising.
7 Poor institutional response
The weak reaction of the Central Bank to previous shocks, and the current political pressure it is under to cut interest rates, raises doubts that the institution will be able to react to possible external shocks The unconventional monetary policy already implemented by the Central Bank strengthens these views.
8 Early elections
Although this possibility is rejected by politicians whenever it comes up, market players prefer to keep it in their pricing. One view is that the government would prefer to hold elections in a good economic environment and take advantage of nationalist sentiments from the success of the Afrin operation. The tensions caused by campaign periods and the general electoral environment are another risk to consider.
9 Moody’s rating reduction
International credit rating agency Moody’s reduced Turkey’s credit rating on March 7 from “Ba1” to “Ba2”, two levels below investable levels. During the week in which the downgrade took place, there was no sales wave in Turkish assets but the effects were gradual.
10 What will happen?
The expectation of economists for the USD/TRY rate for the year, based on the Central Bank’s survey at the beginning of March, is 4.10. However, many investor enterprises expect the Turkish lira to depreciate to the level of 4.25-4.50.