LONDON (Reuters) – Turkey’s lira is in the grip of one of its worst routs of modern times, and markets are sensing more weakness ahead – but also that its central bank will jack up interest rates massively to try to turn the tide.
Roiled by problematic politics, big deficits, double-digit inflation and newly imposed U.S. sanctions, the lira is heading for its worst day, week and month since its financial meltdown of 2001.
The lira slumped 15 percent on the day on Friday, leaving it down more than 40 percent since the start of the year, and as the charts below indicate, there are signs it could lose still more ground.
1/ SCALE OF THE MOVE
The modern lira’s biggest-ever slump was a 36 percent drop over roughly six weeks at the height of the 2008-09 global financial crisis. Its current slide, which began roughly last September, now amounts to 46 percent.
Barring a remarkable fightback in coming months, this will be its sixth straight year of losses. It is also the most undervalued of the major emerging currencies in real effective exchange rate (REER) terms, which measure it against the currencies of trade partners, adjusted for inflation.
Technically the lira’s all-time REER low was in October 2001. Renaissance Capital says this equates to 5.16 per dollar in today’s prices. Friday slump took the lira spot rate to 7 per dollar at one point.
2/WHERE’S THE BOTTOM?
Futures, options and derivatives markets are still blinking red for the lira.
The cost of hedging against big lira swings for the next week using volatility options surged to an all time high on Friday. Traders only make money on these if the currency moves by more than the priced level. That points to big moves, though it could be in either direction.
One-year risk reversals , a gauge of puts (sells) to calls (buys) on lira and a medium-term measure of the currency’s outlook, are at the highest since 2016.
Shorter-term one-month risk reversals indicate even sharper stresses, while one-year forwards are quoted at a 15 percent premium to the current dollar/lira spot rate.
(Graphic: Turkish volatility gauges surge: https://reut.rs/2vwMevc)
The signals from Turkey’s interest rate markets are tricky to decipher with any accuracy in the current maelstrom, but the picture that emerges is that a monster rate hike to try and halt the lira slide is being priced in.
Three-month ‘forward starting swaps’, an indicator of what money markets expect to be charging for three month-funding in three months’ time, are 23.8 percent, well up on Turkey’s current central bank main interest rate of 17.75 percent.
Central bank “credibility is damaged already so they would have to go big,” said Tilmann Kolb, an analyst in the Chief Investment Office of UBS Wealth Management.
“Something around 500 basis points, perhaps higher, it can’t be the 100 basis points that was talked about before the last central bank meeting. That is now too little, too late. It needs to be massive.”
Turkey is no stranger to emergency rate hikes. It jacked up rates by 300 basis points in May and also cranked them up in a midnight emergency meeting in January 2014 after the lira tumbled more than 7 percent in 10 days – which would barely raise an eyebrow these days.