Turkish Lira Carnage Continues: "Prepare For The Messy Endgame"

The Lira - officially the world's most volatile currency - has lost 11% of its value since the start of 2017 (down 8 of the last 9 days against the USD).


In fact, the lira headed for its biggest five-day loss since Lehman (Oct 2008) after a pledge by Turkey’s central bank to support the currency failed to convince investors.


As we noted previously, as Turkey deals with rising domestic instability (and Erdogan's push for total rule), the Lira has become the world's most unstable currency...

As we noted earlier, market focus has turned on the lira as a result of Turkey's large external borrowing requirement which makes its currency one of the most vulnerable currencies to tightening by the Fed.

Not helping matters is that Turkish residents have been flocking to the stability of hard currencies, the opposite of what President Recep Tayyip Erdogan has been urging. As the following Bloomberg chart shows, deposits in foreign exchange for individuals and companies excluding banks rose for a third week, signaling a lack of confidence in the lira. It’s the biggest loser among world currencies so far in 2017.



Additionally, Turkish economic growth has remained sluggish and inflation is rising, yet the central bank has been under pressure from President Tayyip Erdogan not to hike interest rates. A series of gun and bomb attacks have heightened security concerns. On Tuesday the Turkish parliament voted to press on with a debate about constitutional reform to strengthen the powers of President Tayyip Erdogan.


"Nobody wants to be the last one in there and everyone is running for the door. There are no signs from the authorities that they are taking it seriously," said Jakob Christensen, head of EM research at Danske Bank. Christensen said the risk of further attacks was undermining the tourist sector, which is vital for the economy and balance of payments.

Additionally, as Bloomberg's Mark Cudmore remarked, the long-running Turkish lira collapse is accelerating to an unsustainable rate. Prepare for the messy endgame.

The lira has depreciated by 6% in the past week, 13% in the past two months, almost 50% in the past four years. And that’s against the euro-dollar currency basket –- the fall is worse if measured in purely dollar terms.


President Erdogan may be discouraging the central bank from aggressively raising rates to defend the currency but circumstances will soon force its hand.


Turkey has a tremendous external debt problem. There’s nuanced debate about exactly how bad, but it’s hard to argue with S&P’s declaration that it has “one of the weakest external profiles” in emerging markets. Even according to the Turkish central bank’s own data, the corporate sector’s foreign-currency liabilities exceeded assets by a record $213 billion in September.


This means the stress is intensifying, rather than easing, as the currency plummets.


A hike of 200 basis points would probably be insufficient as FX and rates markets are already pricing in more than that. If they want to halt the slide for 2017, my suspicion is that they will ultimately be forced to do at least 300 basis points, even if that doesn’t come through all at once.


This, of course, will crimp growth and have other knock-on problems on the large debt market, which is why Erdogan is trying to resist any action. But the decision is being taken out of his hands.


He’s gone through this scenario before, in both 2006 and 2014, so he’s just going through the motions of denial.


The lira market now has mounting two-way risk and it will be a volatile trader’s market until sufficient hikes come through.

It's not just the currency that is in trouble though. The yield on the nation’s 10-year debt surged 45 basis points, and 5Y CDS just broke above 300bps. The monetary authority said yesterday that it is monitoring “excessive volatility” in the markets and pledged to tackle “unhealthy price formations inconsistent with economic fundamentals.”