Lira Slide To Continue Amidst Central Bank Inaction
In order to stem the ongoing sell-off in the lira, which poses major risks to the Turkish economy, we believe the central bank must abandon its strategy of FX reserve auctions (see 'Reserve Depletion Not A Sustainable Strategy, December 24 2013) and instead, begin hiking interest rates. However, faced with a deepening political crisis that has amplified the need to maintain economic growth in the run up to local and presidential elections in 2014 (see 'Major Implications of AKP Rift', December 19, 2013), we expect the government's aversion to higher rates to continue preventing sufficiently timely central bank action, implying further depreciation ahead.
From a technical perspective, the Turkish lira appears poised for a rebound, with the relative strength index remaining in oversold territory since late December. However, absent a rate hike, we do not expect any significant period of lira appreciation in the coming weeks. In fact, it is our view that even further monetary tightening would be insufficient to spur a prolonged rally, and instead believe a stabilisation would be the most likely scenario in that case.
Robust portfolio capital inflows since 2011 have helped offset depreciatory pressures stemming from Turkey's massive current account deficit, and have coincided with periods of stability and modest appreciation of the lira (see chart above). Rising US yields were already weighing on demand for Turkish assets and the lira in the latter half of 2013, with net equity and government debt securities (GDDS) inflows having peaked at the end of May when the Federal Reserve signalled an imminent taper of its quantitative easing programme. Absent the support of strong growth in capital inflows, and with mounting political uncertainty to weigh heavily on demand for Turkish assets well into 2014, we fail to identify fundamental drivers of lira strength, apart from aggressive interest rate hikes that we view as unlikely at this point given the central bank's pro-growth bias.
|Not Expecting A Turnaround|
|TRY/US$ Spot Rate (Above) & Relative Strength Index (Below)|