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The Turkish lira rallied considerably today amidst continued USD weakness (dollar index down by -0.15%, flashing at 9.34 while articulating) and a number of favorable developments:
1) CBT held rates unchanged, but its statement was interpreted by some commentators as slightly more hawkish; this derived from a newly added phrase that policy would be kept tight until inflation had significantly improved, ignoring base effects and temporary factors.
In our view, this is not really new – perhaps there is some additional emphasis via the clarification that temporary effects do not count, but that could equally work the other way round - meaning, CBT will not hike rates if inflation were to accelerate because of temporary factors. Anyway, we treat CBT's statement as broadly neutral for the lira.
2) Turkey's international relations received an impetus in the past two days after the US Secretary Rex Tillers on backed off from an earlier hawkish stance and said that a secure future for Syria was impossible without cooperation with Turkey. This was a positive unexpected development
Hence, 3m USDTRY put up-and-in is advocated (strike ATMS, barrier 4.20): A possible three-phase scenarios for USDTRY would be:
1) It spikes higher (5-10%) as the markets test the central banks resolve,
2) It forces the CBRT to meaningfully raise interest rates, and
3) A relief ensues and the carry trade community jumps on board (15% carry in long TRY is twice as high as the next major EM currency).
A USDTRY put ATMS with a topside knock-in barrier at 4.20 is 80% cheaper than the vanilla USDTRY put.
The maximum loss is limited to the premium paid. For the USDTRY put strike ATMS to be activated the cross needs to first trade at or above 4.20.
