Big Thursday for currencies. Will CRBT save the Turkish lira?

Summary:

• ECB, Bank of England, Central Reserve Bank of Turkey to decide on rates on Thursday
• A major rate increase seen as a prerequisite for at least a stabilization of the lira
• Other emerging markets to be affected by the CRBT decision

CRBT more important than the ECB, BoE

Normally the ECB meeting is the one awaited by investors and some attention will be surely turned to the post-meeting conference from Mario Draghi. However, with interest rates set to remain unchanged for another year, there’s probably not so much that investors can learn. In case of the Bank of England we had the hike at the last meeting and it’s understood that the Bank would stay put for the next few months. In any case Brexit negotiations seem to have a much larger impact on the pound. Meanwhile, Turkey has started this year’s crisis on emerging markets and there are no signs of turnaround. The reasons of the Turkish crisis extend well beyond interest rates but central bank needs to raise them just to avoid more panic selling. It’s decision is bound to impact other emerging markets as well. The decision will be announced on Thursday, 12:00pm BST.

What will the CRBT do?

We don’t know that but we do know what it must do to avert another panic selling on the lira and other emerging markets. It must raise interest rates from present 17.75% for the benchmark rate to 21-22% expected by the markets. Even 17.75% sounds high, right? So why would the CRBT risk angering president Erdogan with more hikes? Thr problem is inflation. When the CRBT decided to introduce emergency hike in May inflation was at about 12%. So called real rates (policy rates less inflation) were high enough to start cooling inflation down. However, the US-Turkey diplomatic crisis and a resulting plunge in the lira caused inflation to spike to nearly 18% and it might get even higher. Suddenly these high rates vanish when you subtract inflation. The CRBT needs 20%+ rates to restore positive real rates again. It’s not going to end the crisis – this will do nothing to resolve the spat with the US and broader fundamentals (current account deficit, external borrowing needs) will take months or years to improve. But without this move the lira could face another selling pressure.

Interest rates are high in Turkey but so is inflation - that's why markets are looking for another big hike. Source: Macrobond, XTB Research

3 markets to watch:

USDTRY

USDTRY has stabilized lately but it’s not a sign of calmness but paralysis ahead of the CRBT decision. What is more, these levels are still very high and will fuel more inflation in Turkey if they persist. The reaction could likely lead to a test of one of the major levels. If the reaction is positive, traders will be looking towards a support of 5.95 that stopped a recovery from the latest sell-off. Trend line lays so far below that it’s off the radar for now. If the CRBT disappoints, a round number of 7 is a natural point of focus.

Markets are looking for another major rate increase in Turkey to prevent further USDTRY rallies. Source: xStation5

USDZAR

The South African rand has been the most prone currency to the Turkish problems so far. That’s not without the reason. South Africa has a relatively wide current account deficit and the latest attempts to introduce a “land reform” caused unrest among investors. USDZAR has retreated slightly but the upwards trend looks strong. 14.70 seems to be the key support level.

South Africa has its own problems but the USDZAR is likely to be affected by the CRBT decision. Source: xStation5

USDBRL

Brazil is another hot story on the emerging markets scene. Presidential elections – just 4 weeks away – are completely unpredictable and a possibility of a victory from a leftist candidate that could reverse pro-market reforms has already taken USDBRL towards the all-time highs of 4.24. Because of this uncertainty USDBRL could be prone to increased volatility among the emerging market currencies.

Can the USDBRL reverse from the 2015 highs? Source: xStation5