TRY extends its decline after meeting in Washington

Summary:

• Turkish lira touches its fresh record low against the dollar

• The meeting in Washington ends with a disappointment

• Cost of hedging against the further lira’s slump surges

Another day, the same story - the Turkish lira is extending its incredible decline on Thursday after the highly anticipated meeting between Turkish and US state department officials taking place in Washington did not produce any breakthrough. Keep in mind that the relationship between the two NATO allies has deteriorated in the aftermath of detainment of a US pastor. As a consequence, the US chose to hit two Turkish ministers with financial sanctions announcing that further actions could be undertaken. Thus, beside internal woes the Turkish economy faces, the deteriorated relationship with the United States adds fuel to the flames. On top of that, the climate on Thursday is not also TRY supportive as the whole EM block is suffering owing to rising geopolitical tensions. These tensions intensified yesterday when the US administration agreed on new sanctions against Russia in connection with an alleged nerve agent attack Russia was to carry out against a British citizen.

Option traders seem to be gearing up for the further lira’s slump as the cost of hedging against such a move picks up. Source: Bloomberg

The chart above is the best answer what option traders think about the current situation in Turkey. It illustrates that one-month USDTRY risk reversal has climbed to the highest level since 2011 crossing 5%. It confirms a notion that investors do not expect that downward pressure on TRY will subside any time soon, and as a result, they continue hedging against subsequent declines buying call options (it gives the right to buy USD/sell TRY at the predetermined price). Assuming that the latest amazing decline of the Turkish currency will not correct (there are no signs it may transpire by the way), it ought to, and probably will push inflation higher due to surging import prices. Paradoxically, it would act in favour of the lower current account deficit if households and companies cut their spending more than the rise of import prices (the elasticity of the Turkey’s demand for foreign goods and services needs to be higher than one). Moreover, another problem for the Turkey’s economy is heavy reliance on foreign capital. The weekly data shows that an outflow from bond and equity markets keeps moving. Hence, if the capital account worsens further the Turkey will have less money to finance its CA deficit and it could be compelled to cut imports heavily.

The USDTRY keeps on pushing higher with a brief pullback taking place earlier this week. One may assume that a breakout of 5.40 would see the pair rallying toward 5.50 followed by 5.65. Bear in mind that betting against the USDTRY nowaday would turn out a very painful strategy. Source: xStation5