Pressure Builds On TRY
The Turkish Lira (TRY) has been one of the worst-performing Emerging Market currencies over the last several months, even underperforming the Mexican Peso. Given the level of the decline, the market is increasingly expecting the Central Bank of the Republic of Turkey (CBRT) to take action, leading to a potential reversal in TRY direction. While there are risks to a recovery linked to domestic politics, possible ratings agency actions and the external environment, on the key issue of central bank policy it seems that things are starting to change.
The CBRT’s policy response has been accelerating recently and reflects an increased willingness by the CBRT to take more affirmative and creative action to deal with TRY volatility. If the CBRT delivers a rate hike across all policy rates next week and continues their willingness to use the late liquidity window, then TRY could trade better.
Below are a few factors that are necessary for the TRY to start trading better.
More aggressive use of FX swap facility
The FX swap facility can be a sharply effective tool for lifting the cost of shorting/borrowing TRY through FX forwards. This tool has some clear benefits as the CBRT can push the yields on USD/TRY FX forwards to punitively elevated levels in response to pressure on the currency and then reduce them when the pressure dissipates.
This gives the CBRT similar flexibility to the unorthodox “corridor†mechanism through which the CBRT controlled borrowing rates for the banking sector until the recent “simplification process†was finalized. However, the rate on the TRY component of the swap needs to be meaningfully increased.
At the first and second auctions the CBRT offered only 8% and 8.5% respectively with a UD rate of 0.7% and 0.75%. It is possible that the CBRT was only testing the system before applying it more aggressively. As it stands, the swap facility by itself is not enough to spark a TRY rally but it does offer a tool through which the CBRT can address market speculation, particularly by foreigners in the FX forward market which, from recent statements, it appears the government believes is the primary reason for currency weakness.
