Turkish Lira Saved? Maybe Not …

Turkey's central bank is making an effort to restore some credibility to its faltering currency after failing to defend it by means of Forex interventions last week. In defiance of political pressure (probably making use of the currently weakened position of the government), it has raised rates at a special meeting that has been breathlessly awaited by market participants. And it didn't exactly announce  baby step rate hikes either:

“Turkey’s lira strengthened the most in more than five years and bond yields declined after the central bank raised interest rates and signaled a return to a simpler monetary policy. Stocks fell.

The Turkish currency appreciated as much as 4 percent to 2.1626 per dollar, the biggest gain since November 2008. Yields on two-year benchmark notes fell 36 basis points to 10.70 percent and the Borsa Istanbul 100 Index of shares dropped 1.4 percent.

Governor Erdem Basci is fighting to halt a currency run that gained speed amid domestic upheaval and a global rout of emerging markets. Prime Minister Recep Tayyip Erdogan, who said yesterday he’s always opposed higher rates, is caught in a graft scandal that has ensnared several ministers and the chief executive officer of a state-owned bank. It spooked investors just as the reduction of monetary stimulus in the U.S. began sucking money out of riskier assets.

[….]

The central bank raised all its main interest rates at an emergency late-night meeting in an effort to shore up the lira, resisting government pressure and reversing years of policy aimed at stoking growth. The lira gained for a third day, adding 1 percent to 2.2313 per dollar at 1:06 p.m. in Ankara, paring losses that sent it to records lows against the dollar in eight of the previous 10 days. Interest rates had been on hold since August.

The Ankara-based bank increased the one-week repo rate to 10 percent from 4.5 percent, the overnight lending rate to 12 percent from 7.75 percent and the overnight borrowing rate to 8 percent from 3.5 percent. The central bank said the one-week repo rate, now at 10 percent, should be treated as the benchmark policy tool.”

Several points are worth noting. First of all, although the rate hike was very large, the central bank is merely catching up – rates were kept way too low for much too long, igniting an unhealthy boom that was already threatening to falter of its own accord lately. For some time the huge decline in the currency's value apparently didn't bother anyone, but that changed when the decline became a tad more pronounced and disorderly recently.

Secondly, it remains to be seen whether prime minister Erdogan is going to take this show of defiance lying down. Turkey's central bank is of course also officially  'independent', and it could be that he will accept its decision due to being already in political trouble and perhaps because even he realizes that there are no longer any painless options left to it. However …

Market Participants Have Second Thoughts

Market participants appeared to have second thoughts after the initial strong rise in the lira. One must of course keep in mind that it already strengthened in anticipation of the central bank's emergency meeting,  so an element of 'sell the news' may have been expected. Still, given the steep increase in rates, the result has been rather non-climactic so far:

A 15 minute chart of the Turkish lira vs. the US dollar, showing the action following the rate decision. Around noon, not much of the initial effect was left – click to enlarge.

A daily chart shows us how big a move has already taken place in anticipation of a strong rate hike. This needs to be put further into perspective however. Certainly the move from extremely oversold conditions was quite a big one in a very short time. However, as the weekly chart further below shows, so far it is still only a blip in the bigger scheme of things. A part of the decline that occurred when outright panic gripped the market in recent weeks has now been reversed, but it is not yet certain whether the central bank's moves will actually alter the trend for good.

USD/TRY daily: it moved sharply lower (this chart depicts lira per USD, so a decline indicates a stronger lira) for two days in anticipation of the central bank announcement – click to enlarge.

A weekly chart of the USD/TRY pair starting in 2008 – the two red arrows show the distance between the current exchange rate and the recent intraday-high. It is possible the the lira will reverse course from here, but the notion that the recent action might merely be the beginning of another volatile consolidation period cannot be dismissed yet – click to enlarge.

One reason why one must remain a bit skeptical is that neither Turkey's stock market nor its bond market benefited much from the alleged removal of uncertainty. In fact, they both kept declining, with stocks ending the trading day at a new closing low for the year.

The Istanbul 100 index: a new closing low for the year. In fact it is now near a lateral support level that was established in early 2012 – click to enlarge.

Conclusion:

Turkey's central bank certainly showed some unexpected resolve, but this doesn't necessarily mean that the country is out of the woods yet. For now it does not yet appear as though the markets are thoroughly convinced. Nevertheless, the boldness of the action deserves some kudos. Not to worry, we haven't thrown our views about the futility and harm of central banking overboard, we merely note that this is a case of a central bank trying to act a tad more responsibly in the face of what is reportedly intense political pressure.

Update:

Shortly after we wrote the above, USD/TRY surrendered all gains, amid an ongoing general emerging market rout. Gold caught a bid and stock index futures fell slightly. By the time the FOMC decision is announced, things could change again, and we will comment after we know how things have shaken out in the end. Anyway, this was a pretty strong reversal, considering there was still a degree of euphoria in stock markets early in Asian trading (with the Nikkei recapturing more than 400 points). 

Within an hour of writing the above article, we witnessed the lira falling out of bed again. Stability this is not – click to enlarge.

Gold, February contract, 20 minute chart a little over an hour after the COMEX open - click to enlarge.

Charts by: Investing.com, BigCharts