"Whispers Of Capital Controls" As Turkish Lira Resumes Crashing

Update: not long after we published this, the Lira plunged some more, tumbling more than 4% on the day after some comment from the ruling party that could have been... avoided:


* * *

As widely expected , the beneficial boost to the Turkish Lira from yesterday's emergency 3% hike in the late liquidity window rate by the Turkish Central Bank did not even last one full day, and on Thursday the Turkish Lira collapse resumed, with the currency reversing much of yesterday's gains, sliding as much as 3.5% - the biggest decline across Emerging Markets - amid the previously discussed concerns that the rate hike will provide only temporary support.

The central bank acted after three weeks of turbulence in the currency market, with the lira rallying 2 percent by the end of Wednesday, although as of this morning those gains are now lost, and judging by the chart below, Erdogan's demand that Turks not exchange their rapidly devaluing currency into dollars and other foreign currency has made them do just that.

Additionally, as Bloomberg's Stephen Kirkland notes, the market is about to test president Erdogan's vow not to intervene in monetary policy: "beyond fueling the debate over whether Turkey's 300bp was enough, today's lira about-face also tests the central bank's tightening resolve, as well as Erdogan's vow of allegiance to global principles of monetary policy."

It's still early going for Turkey's topsy-turvy market and the next catalyst comes from Erdogan himself, as he kicks off his re-election campaign today. Key to stabilizing the lira will be his tone and whether he sticks to yesterday's script, especially since his past comments involved blaming higher rates for inflation and accusing speculators of attacking the economy.

President Recep Tayyip Erdogan, who’s seeking re-election in a June 24 vote, didn’t specifically mention the rate increase in a televised speech Wednesday, but sought to reassure investors by pledging allegiance to global principles on monetary policy.  He’s due to kick off a campaign for re-election on Thursday, as polls suggest he may face a tougher challenge than in the past.

Until then, trader nerves will be on frayed: "Is lira weakness avoidable? Perhaps not so much, considering Turkey’s high inflation and large external financing needs,” said Emre Akcakmak, a Dubai-based portfolio adviser at East Capital International.

As shown in the chart below, this trade jitteriness has manifested in the biggest surge in TRY implied vol since the financial crisis.

Potentially adding to the confusion, Bloomberg's Anchalee Worrachate writes this morning that "whispers of capital controls have re-emerged", as "Turkey's currency dilemma may be deja vu all over again for investors wary of the fraught history of capital controls."

Back in September 1998, Malaysia's measures to counter outflows and fix the exchange rate drew criticism from the IMF. But Paul Krugman supported it, writing in a Fortune magazine article that "currency controls are a risky, stopgap measure, but some gaps desperately need to be stopped."

I'm not suggesting capital controls are even an option for Turkey. Yet the judgment by some that yesterday's rate hike was a temporary fix -- particularly as the lira resumes weakness today -- underscores the need for measures to give policy makers breathing room on the currency.

Meanwhile, as we summarized yesterday, analyst remain skeptical the one-off intervention by the CBRT will be successful: The rate increase “won’t trigger a sustainable reversal in USD/TRY after confidence has been shattered over the past few weeks,” said Piotr Matys, an EM FX strategist at Rabobank in London. "More is required to restore confidence among investors and the central bank may have to tighten monetary policy further perhaps as soon as on June 7."

The good news is that while the currency rout has returned, so far it has spared other Turkish assets as stocks and bonds rallied. The yield on Turkish 10-year debt dropped 23bps to 14.04%, the lowest level since May 14, bringing it’s three-day decline to 54 basis points. The benchmark Borsa Istanbul 100 Index rose 1.4 percent, led Akbank and Turkiye Garanti Bankasi.

A recap of what some other analysts and traders say is below, as first noted yesterday and recapped courtesy of Bloomberg:

Tatha Ghose, an analyst at Commerzbank

  • “It may suffice for the near term if global markets also turn supportive.” Otherwise, it’s only a brief pause
  • Interest rates may have to rise to 20% to control the rout

Kiran Kowshik, a strategist at UniCredit in London

  • The lira could rebound to about 4.4 per dollar
  • Erdogan is likely to be a bit more hawkish on the FX side in his pre-election speech tomorrow, which should support the lira
  • In medium term, rate hikes aren’t likely to help the lira, given the still-widening current account deficit and apparently low sensitivity of inflows to interest rates
  • “Hence TRY will likely remain an under performer further out”

Alejandro Cuadrado, global head of foreign exchange at BBVA

  • Rate hike should be enough to stem selloff, but more is needed to restore credibility
  • Tightening topped initial BBVA’s expectation of 250 basis points
  • "More signals may be needed, otherwise the adjustment higher in USDTRY remains inevitable"
  • Forecasts a potential level of 4.4 in 2Q, as high volatility and possible corporate demand complicates the picture

Delphine Arrighi, a money manager at Old Mutual in London

  • Hike might be "just enough" to calm the market, but more needs to be done to reestablish credibility
  • Reduced short TRY position to market weight
  • Without economic policy turnaround, TRY may weaken more medium-term

Shamaila Khan, director of emerging-market debt at AllianceBernstein

  • Hike is a step in the right direction, but won’t be enough to change market sentiment
  • "The positive impact will only last if the CB continues to pursue a hawkish policy; a one-off will not change sentiment except in the short term"
  • We have not seen policy response to address the imbalances

Erik Nelson, a currency strategist at Wells Fargo in New York

  • More commitment to deal with high inflation will be needed over the longer term
  • "Without more concrete and sustained signs of central bank commitment to bringing down inflation, the Turkish currency will likely remain under pressure going forward"
  • “We would maintain a bearish view on the currency over time unless there are more sustained actions"
  • Forecasts the TRY to end 2Q at 4.3, but says there are some upside risks to that estimate

Timothy Ash, a senior emerging-market sovereign strategist at BlueBay Asset Management

  • Turkey may need to raise rates again as policy makers are “far behind the curve”
  • Credibility of Turkey’s central bank has been “shot to hell” over the past month, he says on Twitter

Win Thin, New York-based head of emerging-markets strategy at Brown Brothers Harriman

  • 300 basis points is “a very weak response” to the depreciation in the lira
  • Any currency relief “is likely to be temporary if this is all that the bank is doing”
  • Central bank should have raised to at least 20%

Anders Faergemann, a London-based senior fund manager at PineBridge Investments

  • “I’m not convinced 300 bps are enough at this stage to stabilize the Turkish lira. A week ago, maybe, but as of today my sense is that the market has moved on and I would have preferred the Central Bank of Turkey to have surprised the market and regained some type of control with inflation expectations”

Cristian Maggio, head of emerging market strategy at TD Securities

  • “This is a relevant move for sure if they’re serious about tightening and fixing the inflation problem. However, they must be ready to do more if needed”

Paul Greer, a London-based money manager at Fidelity International

  • Rate hike is enough to stabilize the lira in the short-term as some of the large short Turkey positioning will now quickly unwind, which will support the market
  • However, the Turkish central bank’s credibility has been badly damaged during this episode of sharp lira depreciation
  • “If the Turkish authorities had wanted to get well ahead of the curve, reduce inflation expectations on a more sustainable basis and to drive down Turkey’s long-dated debt funding costs over the longer term, they should have delivered an even larger hike than +300bp and also accompanied the hike with a simplification of its monetary policy tools”

Philip Wee, among other analysts at DBS Bank Ltd.:

  • It is too early to conclude that the worst is over for the Turkish lira even after the currency rebounded from a record low
  • There’s concern about “effective policy making” under Erdogan
  • Erdogan’s administration still needs to address the causes, not the symptoms, of the lira’s rout