Will Turkish Lira’s Comeback be Sustainable Based Just on CBRT’s “Whatever It Takes” Stance?

FT wrote that Turkish Lira was “a rare bright spot for emerging market currencies in July”. Indeed, Lira has been topping the Fx advance list for nearly a week with daily increases against USD of up to a full percent. It has appreciated 2.5% since the beginning of the month, but remains over 12% lower YTD. The Lira’s performance puts it out of the crowd of other major emerging currencies such as the South African Rand and Brazilian Real, frequently cited by various media as strong performers this year, although notable having fallen behind since U.S. Fed updated its policy guideline for the next year given new inflationary trends. What key events have been driving the Lira’s performance lately?

The uncharacteristic Lira’s stability follows a slump of the currency in March after Erdogan memorably fired the central bank governor, replacing him with Sahap Kavcıoglu, who shares the president’s unconventional view that raising interest rates fuels rather than tames inflation. Despite the change in leadership, interest rates stayed on hold at 19 per cent earlier in July for the fourth straight month after inflation accelerated to 17.5 per cent in June.

On Thursday, as the Turkish central bank has upwardly revised its year-end inflation forecast to 14.1% from 12.2%, its governor Kavcioglu reiterated his pledge to maintain tight monetary policy and keep the benchmark interest rate above inflation “until strong indicators point to a permanent decline in inflation and the medium-term 5 per cent target is reached”.

Back on March 19 this year CBRT decided to hike its policy rate by 200 basis points from 17% to 19% pleasing EM investors, while market expectations were for around 100 basis points increase. Following the surprising move, the U.S. dollar/Turkish lira exchange rate decreased by around 1.5-2% to around 7.35.

Although many EM countries’ financial regulators followed its footsteps to date, with the Central Bank of Russia appearing the hike leader with a total 200 b.p. key-rate increase over just three consecutive policy meetings, CBRT is still considered an early bird and continues to reap the juiciest fruit.

Also, the Turkish currency continues to benefit from yield-seeking investors’ return into Turkey’s Lira-denominated bonds (known as a carry-trade phenomenon). The prospect of monetary tightening from the U.S. central bank arriving sooner than previously anticipated has somewhat firmed the dollar against a broad range of global currencies.

Some investors are doubtful the Lira’s comeback will last. But one thing still enables CBRT to retain its high score – namely, demonstration of readiness for bold swift moves following possible dramatic changes in both ongoing inflation data and Lira’s exchange rate fluctuations.

All-in-all, Lira’s performance remains backed by the two main non-quantifiable factors, in which we are free to believe or reject, namely: a) that the worst in terms of inflationary spike is over, with CBRT enjoying the FIFO principle (“first-in-first-out”); b) that Lira remains in epicenter of global carry-trade, which is a very powerful thing on its own.