Turkish Lira: Calm Before the Storm?

How much damage can this EM currency bear before it breaks?

The overnight rate on the Turkish Lira went into hyperspace yesterday, soaring to over 1,000% as a freeze on lira liquidity caused anguish for foreign investors caught on the wrong side of the carry trade.

Deeply negative real rates and a compounding trade deficit have been flashing warning signals for the lira, causing economists to recommend rate hikes as a solution.

This proposal has been met with tremendous backlash from the Erdogan administration, as the President remains committed to pumping cheap credit into the Turkish economy, particularly at a time when the nation of 82 million has seen its tourism revenues vanish into thin air due to coronavirus.

As mayhem unfolds in the currency market, pressure mounts from the international community on the central bank of Turkey, and particularly its leader, Governor Murat Uysal. Just this morning Goldman announced that it sees the policy rate increasing from 8.25% to 14% by the end of 2021.

Because it can’t raise rates, Turkey has been selling dollars in order to stave off a correction in the FX market, selling much of its dwindling reserves from its central bank as well as encouraging local banks to sell dollars and preventing them from selling lira to foreign investors. So that’s why foreigners had to borrow lira in offshore market, hence the massive short squeeze.

Now it’s unclear if these foreign investors were hedging their lira-denominated assets, or if they were on a pure bear raid. The Istanbul National Stock Exchange was down 3.5% yesterday, maybe that’s connected, I don’t know. What I do know is that it’s going to be an interesting few months ahead for the Turkish Lira.