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The Turkish lira continued to suffer volatile swings last week. There was brief relief when global risk recovered somewhat following positive developments in Italy; CBT resumed its 'normal' repo auction on Friday (at the higher 16.5% interest rate as it had promised) - this was a sign that the monetary policy framework is reverting back to a simple, orthodox one – this is good. But the lira's fragility, under the surface, was clear for all to see: USDTRY refused to stay below the 4.50 mark for long. Today, we get May CPI and PPI data: the market consensus expects headline inflation to have accelerated past 12%y/y in May; core inflation could have accelerated from 12.2% towards 13%.
These readings, however, do not yet fully reflect the impact of the lira depreciation which occurred during May – some of the wholesale and foreign PPI inflation indicators are beginning to reflect this (as we saw with wholesale prices in Istanbul, which rose by 2.6%m/m), but we will see the full results only after around three months' time.
Government leaders are already confidently predicting that the inflation impulse will peak in just a few months' time. In some ways, it is their job to sound reassuring so that the market does not panic when bad prints are released. Nevertheless, markets are sophisticated enough to decide for themselves whether policymakers are in control or in denial.
The inflation impulse which is about to hit Turkey will take a high positive real interest rate to tame; CBT simply can't afford further bouts of lira sell-off. CBT has promised to raise rates if inflation accelerates – it has talked the talk. The market will give it only one chance to live up.
Overall, the tendency for inflation would be to peak and moderate – but only slightly, say to around 9% in the coming months. This extent of moderation will not neutralize Turkey’s long-term inflation, though – at the best, it can bring near-term relief. In the medium-term term, for the stabilized lira, we, therefore, expect USDTRY to head up towards the 5.00 mark.
Trading tips:
At spot reference: 4.6287 levels, short 2m ATM calls, Sell 1Yx1Y USDTRY FVA vs buy 1Y ITM call.
Buy 2m USDTRY call (4.50) and EURTRY call (4.83) (equal weighted USD notional).
Currency Strength Index: FxWirePro's hourly USD spot index is flashing -125 (which is neutral) while articulating (at 12:25 GMT). For more details on the index, please refer below weblink:
http://www.fxwirepro.com/currencyindex.
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