01.04.2019 – Special report. The regional elections in Turkey have been held, now the financial market is reacting. Ankara has completely destroyed confidence. The question is whether the Turkish central bank must give up the support of the lira. A sell-off seems more than possible. Unless the country on the Bosporus reforms and returns to its former economic strength.
First warning from Moody’s
After the election, the Turkish lira lost only moderately, the question is whether it will stay that way. The rating agency Moody’s fired a warning shot: according to a CNBC report on Monday, the agency complained about the Turkish central bank’s use of the alarmingly shrunken forex reserves to support the lira. The action taken immediately before the regional elections had heightened doubts about the independence of the currency guardians. Moody’s verdict: “Credit Negative”.
Feud against investors
Yesterday’s election on Sunday thus not only brought the autocrat Recep Tayyip Erdogan a lesson – his AKP lost in the capital Ankara for the first time in 25 years. Erdogan has also angered international investors. A week before the local elections he had been raving: “Whoever bets against our currency pays a high price”. Shortly afterwards, the Turkish regulatory and supervisory authority reported that it was investigating several banks investing short in the Turkish lira, including two bankers from JP Morgan in Turkey.
Lira short squeeze
Tuesday last week Turkey finally rode an unprecedented attack on shorts. The overnight swap rate shot up to a horrendous 1338 percent. Lira’s loan thus became unaffordable. Bankers and analysts reported that not a single Turkish lender wanted to lend even one lira. Despite denials by the Turkish banking association, the financial market was assuming an order from Ankara. Brokers spoke of Turkey’s financial suicide. After Thursday last week, the swap rate slipped back to the usual levels of up to 40 percent. The market in London had thawed out and Ankara had to surrender.
Forex reserves burned
Last Thursday, the shock mentioned by Moody’s: the Turkish central bank reported a slide in its holdings of gold and hard currencies to 24.7 billion dollars on 22nd March. The week before, the figure had been 28.5 billion. The lira immediately submerged. The Financial Times suspected that in March alone Turkey burned about a third of its forex holdings to support the lira.
The governor of the Turkish central bank, Murat Cetinkaya, was still trying to smooth the waves. He told state news agency Anadolu that net reserves of foreign currency had risen by $2.4 billion in the last few days of March. The financial blog “ZeroHedge” suspected that this was due to a simple accounting trick: in the days before the election, the state authorities had raised the minimum deposit limit for forex Lira swaps from 10 to 30 percent.
Fleeing Turkish assets
The short attack put the axe on investors’ will to buy. Turkish government bonds and shares were thrown onto the market. The cost of five-year credit default swaps was recently higher only in Ukraine, Argentina and Lebanon. Confidence has already been damaged by the ongoing economic misery: From February 2018 to February 2019, prices in Turkey rose by around 19.7 percent. The unemployment rate is 13 percent, the key interest rate 24 percent. Loans can hardly be paid anymore, the amount of bad loans at Turkish banks increases.
Reform or final capitulation
The question is, when will the last hard-boiled long investors leave the country? The horrendous volatility over all assets alone is likely to classify the country as ineligible. One argument, however, speaks for the recovery of the lira: Turkish companies have taken on a lot of debt in dollars. If the lira becomes too soft, debt service will become unaffordable. Ankara must therefore save the lira. Or finally push through reforms. The low-wage country used to profit from the production of cheap export goods – the textile industry in Euroland Greece has been destroyed, while it is booming in Turkey.
The risk of contagion for markets such as Brazil or Indonesia is high due to the crisis in Turkey. Emerging market funds are likely to divest assets in other emerging markets because of Turkey in order to reduce their entire VAR (value at risk). Since the Federal Reserve slightly raised US interest rates, capital from risky markets has increasingly been flowing into the United States anyway.
Recovery or final lira shock?
Traders are now waiting for signals to improve. The lira is the indicator. It has lost around 30 percent of its value since the previous crisis in the summer of 2018. In the past five years, there has even been a minus of around 63 percent in the books. Obviously even the Turks fear a crash of the lira to the crisis levels of last summer: According to data from the central bank, domestic investors now hold around 176 billion dollars in foreign exchange. We are curious to see how the Turkish lira will continue – and wish you a successful day trading!
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