FxWirePro: Spike in Turkish tourism seems trivial against widening current account deficit, lira still fragile – Uphold bullish hedging

The lira continues to be on tenterhooks as Iran sanctions hearings in the US proceed. Yesterday did not bring fresh adverse news on this front, however. Meanwhile, the Tourism Ministry published tourist arrival figures for October. Minister Mehmet Simsek stated that arrivals were up 28% for January-October and that this recovery looks set to continue.

However, year-on-year measures are all over the place because of base effects from the coup and Russian sanctions in preceding years. Absolute numbers show that tourism has indeed recovered to near pre-2016 levels, just slightly below. A weak lira and no further high profile terrorist incidents are probably responsible. Numbers from Germany were subdued.

Readers should bear two points in mind:

1) Arrivals may now have rebounded from their lows of 2016, but there is no strong growth trend underlying the sector.

2) The seasonal peak for this year is over and absolute revenue from tourism will now rapidly fall through the winter; Turkey's current-account deficit has begun to widen out just at this wrong time when tourism is less able to act as a counter. Turkey's current-account deficit widened to $4.53bn in September, worse than consensus expectations. On a seasonally-adjusted basis, September saw nearly a doubling of the gap to $6.1bn from $3.2bn in August, with the rolling 4-quarter deficit as the percentage of GDP reaching 5.8%.

In nutshell, the tourism numbers have normalized to a large degree, but this is not a dominant factor for the lira right now, which faces other major challenges.

FX options trade:

In outright trades, we recommend buying a 2m 4.10 USDTRY call.

The options market has so far priced in only a moderate deterioration in the outlook for lira with close to average levels of implied volatility and skew.

However, as we are in our view now transitioning towards our “bear case” scenario of an increasingly negative feedback loop between the currency, asset prices, and outflows, we can envisage a much more fragile pattern before the central bank is forced to step-in in a credible manner.

The situation is likely to be exacerbated by negative current account seasonality in December and low liquidity around the year-end.

We, therefore, recommend buying a 1m USDTRY 4.10 call indicatively priced at 1.26% (spot ref. 3.9359) to take advantage of the likely rise in volatility and skew as USDTRY trades higher. The risk on the trade is limited to the premium paid.