The Turkish lira (TRY) has had a weak year on foreign exchange markets so far. In the first seven months of 2024, the US dollar has gained over 12% against the Turkish currency to trade at 33.0158 at time of writing.
The world’s leading financial institutions are divided as to whether the lira will recover in the remainder of 2024. The global credit ratings agency S&P forecasts that the lira will weaken further to trade at 40 against the dollar by the end of 2024, 42 at the end of 2025, and 43 at the end of 2026. However, there have also been bullish calls on the lira.
Citibank recently announced to clients that it had gone long on the Turkish currency, saying “we are now selling USDTRY six-month forwards, as we believe the currency may further absorb better flows over the next couple of months.” JPMorgan have similarly expressed optimism about the future trajectory of the Turkish lira.
“We believe the risk-reward on long lira has improved again. The structural improvement in the current account, together with the additional monetary policy tightening delivered and promised fiscal tightening, allow prospect for current-account surpluses; local dollarisation pressure in March can reverse, reacting to improving real yield profile,” the investment bank said.
These discrepancies are perhaps an indication of the turbulent Turkish political scene, which makes it difficult to predict movements on lira markets with any real degree of confidence.
The Turkish lira’s sharp depreciation started particularly with the Covid-19 pandemic and then the war in Ukraine, which caused traders to seek safe haven currencies such as the US dollar. Higher interest rates in the States, after the Fed started tightening monetary policy in response to high levels of post-pandemic inflation, also encouraged traders to obtain greater exposure to the dollar in order to benefit from the higher yields on offer. This hammered the Turkish lira and many other emerging market currencies.
However, the lira was particularly vulnerable owing to Erdogan’s pursuit of unorthodox monetary policies in the years prior to the 2023 election. Erdogan has long expressed the view that the answer to higher inflation is to cut interest rates, something that has served to stoke runaway inflation (prices are currently rising in Turkey at a rate of over 75%).
Since the election, however, Erdogan has pivoted to pursue much more orthodox policies. He has appointed Wall Street bankers and conventional economists to key economic posts, including at the finance ministry, which is currently being headed up by Mehmet Simsek. Simsek’s reforms have already started to yield results – capital inflows are on the up, the exchange rate has stabilised, and foreign reserves have been steadily accumulated.
It is in this context that banks such as Citi and JPMorgan have become more optimistic that the lira could start to make gains. They clearly believe that Turkey is on the right economic track and is therefore in line for greater foreign investment flows, boosting the lira.
The high interest rates that have been introduced in order to bring inflation down and pivot Turkey to conventional monetary policies – rates are currently at 50% – are further incentivising traders to trade the lira and lira-denominated assets. Indeed, since last October, money managers have poured around $24 billion into trades designed to profit from high rates. Since last June, foreign investors have also bought up around $12.5 billion in bonds priced in Turkish lira.
Crucially, however, a significant chunk of this exposure is in the form of “fast money” flows which means that investors such as hedge funds can rapidly exit if needed. Put another way, investors remain fickle and are not necessarily fully convinced about the future of the Turkish economy. Even Oxford Economics, which has “recently moved the [Turkish lira] to an overweight in our emerging market portfolio,” accepts that there are “high risks to our call given Turkey’s weak external position.”
While there are reasons to be optimistic that Turkey’s economic reforms could lead to lira appreciation, there are no guarantees. Erdogan has changed course before and could do so again. Even if he does not, Turkey’s low foreign reserves, the continued global strength of the US dollar, and geopolitical tensions in the region are just three factors which could cause continued volatility and weakness on lira markets.
The position of the lira is not clear at all – hence the contradictory calls which are coming from global banks on the currency.
Author: Harry Clynch
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