FxWirePro: Macro risks conducive for EM currency space, especially for magnitude in TRY vols

Macro levels risks continue to drive global financial markets, with the Brexit June 23rd referendum on membership in the European Union likely to result in emerging market currency depreciation should a “Leave” vote prevail, in the context of heightened market uncertainty.

A flight toward safe haven assets and likely contagion fears regarding broader European disintegration. We reckon during such an environment, volatility in USDTRY is likely to climb, while TRY (and other EM currencies, broadly) may depreciate against USD.

Key risks for trade include “Remain” vote prevailing in UK referendum and macro risks dissipating:

A win by the “Remain” campaign in the June 23rd UK referendum would likely lead to outperformance in emerging market assets, including TRY, and produce lower USDTRY volatility, thereby causing this trade to underperform.

Additionally, more dovish rhetoric from the FOMC may push back further the market’s anticipated timing of Federal Reserve hikes, and help EM currencies to rally, while dampening currency volatility.

Strong net inflows into Turkish government bonds over the coming months would also help TRY to strengthen, leading to deterioration of the recommended position.

Furthermore, this trade may underperform if the CBRT turns more hawkish than expected and refrains from additional cuts to the upper overnight lending rate at the upcoming rate-setting meetings.

The Turkish lira has shown remarkable resilience over recent months, helped by stronger-than-anticipated economic performance (1Q 2016 GDP growth registered a robust 4.8% YoY), postponement of concerns regarding imminent Federal Reserve interest rate hikes, and the improved predictability of power embodied in AKP’s return to the country’s helm.

However, a number of event risks lurk in the weeks ahead that may undermine TRY currency strength and lead to an accompanying increase in market-implied currency volatility.