FxWirePro: Double whammy for TRY from CBRT and Moody’s, USD/TRY spikes - OTM calls in diagonal credit spreads to fetch exponential yields

After CBRT’s rate cut in last week, Moody’s downgrading has been the double whammy for USDTRY, as the pair has been spiking considerably.

President Tayyip Erdogan unsettled markets briefly on Friday when he appeared to focus on the central bank, remarking that Gulenists (FETO) will be removed from the central bank too and that the MPC should lower rates progressively. These remarks, however, should be viewed in context -- Erdogan was being asked questions while abroad -- he should be expected to reiterate his views on a wide range of topics; this does not necessarily amount to stepping up his rhetoric.

Following the failed coup, he also asked bank managements to lower mortgage rates, which banks duly did. Hence, Friday's remark about banks lowering lending rates does not constitute a departure either. Overall, the remarks portray only a slight more urgent tone, perhaps because the economic data have weakened markedly. We continue to expect CBT to cut rates twice more by 25bps in the next two months.

In addition, late Friday evening Moody's downgraded Turkey's credit rating to junk status. We expected downgrades to manifest due to the deteriorating growth outlook and Moody's didn't disappoint, citing the growth deterioration and doubts about the ability to service external debt. In terms of market reaction, we can expect weakness in both TRY and cash bonds. We don't expect a severe reaction in CDS space as Turkish CDS already trades at sub-investment grade levels. All told this was an inevitable decision in our view. Low rates of growth and a poor domestic political backdrop are hardly conducive to a benign investment climate.

While we had already anticipated USDTRY’s upswings in our previous write up and recommended the option strategy accordingly.

For more reading on our previous analysis please follow below weblink:

http://www.econotimes.com/FxWirePro-Dovish-CBRT-stimulates-USD-TRY-upside-risks-1w-calls-exorbitantly-priced-%E2%80%93-Construct-Diagonal-Credit-Call-Spreads-bidding-tepid-IVs-315945

Well, 1% OTM calls expiring on 21st of this month (that have been advised in the above strategy) have shown almost more than 9% returns (i.e. from TRY 2718 to TRY2965).

Technically, after testing trendline support, the pair has formed a gap up candle that has spiked above DMAs which is the bullish sign. We could foresee prevailing upswings to drag further towards 3.16 levels upon breach above resistance of 2.9939 levels. Consequently, the OTM options are most likely to expire in the money on before expiration.