FxWirePro: Hedge USD/TRY via RV derivative trades on mounting sentiments of rate hiking and …

FxWirePro: Hedge USD/TRY via RV derivative trades on mounting sentiments of rate hiking and political tumult

Monday, May 28, 2018 1:41 PM UTC

This write-up runs us through the parallels between Italy and Turkey. President Recep Tayyip Erdogan too blames the messenger, in his case: the financial markets (implicitly: the foreign financial markets) for the lira crisis. Why do these things always work along exactly the same lines? Despite the fact that in the case of Turkey the situation is as clear as daylight. In this case, it was clearly and without any doubt the President himself with his comments on monetary policy who caused the collapse of the lira.

The fact that he is calling on his fellow Turks to square their foreign currency holdings to support the lira, therefore, does not lack a certain irony. His verbal demonstrations of power against the financial markets only make matters worse. His announcements that he will “soon deflate the exchange rate bubble” and “we will spoil this game” are going to be interpreted by many observers as an implicit threat of capital controls. If this fear spreads that would become a worst case scenario for the Turkish balance of payments and the lira.

These sorts of concerns could easily cause the financing of the Turkish current account deficit to come to a sudden stop. The lira weakness that we have seen so far would constitute a walk in the park compared to what would be on the cards in that case. At present, the TRY market is on the cusp.

USDTRY exchange rates in the 4.60/4.70 range are too high for the emergency rate hike on Thursday to be seen as a success, but they are not so high as to be able to declare the step a failure. Should the favorable interpretation of the situation in Italy as stated above, fuel risk appetite on the markets, in general, the situation could change in favor of the lira. If Erdogan continues to sound as he did over the weekend on the other hand, there is a latent risk that periods of recovery such as that would come to a rapid end.

In our opinion, such a choice does not even exist. The same rate hike, which could have stabilized USDTRY at 4.00 if undertaken last month will only succeed in holding the exchange rate down at 4.30-4.50 if undertaken now, and this level will move up to (guess!) 6.00 if done in June. The market is testing CBT’s resolve and independence; it will keep moving unless we have proof of life. Courtesy: Commerzbank

Hence, we advocate below derivatives strategy with a view to arresting further upside risks.

Trade recommendation: Short 1Yx1Y USDTRY FVAs vs buy 6m ATM +0.51 delta call options.

Currency Strength Index: FxWirePro’s hourly USD spot index has shown 90 (which is bullish) while articulating at 13:12 GMT. For more details on the index, please refer below weblink:


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