Turkish Lira Completes A Post-Election Reversal As Central Bank Waits On Inflation

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Includes: TUR
by: Duru

Summary

The Turkish lira has fully recovered from its post-election losses.

The Turkish Central Bank seems content to wait on inflation rather than take action.

This makes for a critical juncture on the currency which I still anticipate will resolve into renewed weakness.

Since I laid out a post-election trading strategy on the Turkish Lira (USD/TRY) two weeks ago, events have gone on a very slow burn. The currency and the stock market have been surprisingly calm overall despite the unfolding wrangling to form a government. Post-election gaps filled this past week.

iShares MSCI Turkey ETF (NYSEARCA:TUR) quickly filled the post-election gap but ahs stalled at resistance from the 50-day moving average

The Turkish lira has also filled the post-election gap and now pivots around its 50-day moving average

Source: FreeStockCharts.com

So the narrative for a complete reversal of the post-election gap played out after all. The bounce on USD/TRY lasted just three days. While I closed out the long trade after that momentum ended, I decided to accumulate USD/TRY all over again shortly thereafter. A break below the May low will trigger reconsideration as such a move would mark higher odds of an end to the multi-year uptrend. I expected a rebound in the U.S. dollar (NYSEARCA:UUP) and on-going selling in emerging markets (as represented by iShares MSCI Emerging Markets ETF (NYSEARCA:EEM)) to catch up with the lira. Instead, the lira has overcome both negative catalysts. If the environment for carry trades were better - meaning volatility was more likely to go down than up in the future - I would have immediately switched positions to bullish on the Turkish lira after this kind of gap fill.

There remains an important economic wildcard looming over this trade. As the charts above show, the Turkish central bank issued its latest statement on monetary policy on June 23, 2015 (I used Google Translate to read it). That event happened to coincide with the current top on TUR. The Bank decided to keep rates constant despite the weakening currency. The continued lack of action implies that the Bank may still feel political pressure to avoid rate hikes even after the recent election should have relieved some of this pressure.

On the inflation front, the Bank seems content to hope inflationary pressures abate on their own. The Bank blames high food prices for current inflation levels. At 8% the inflation rate is high relative to developed economies, but it is very low relative to past decades in Turkey. So, it seems plausible that the Bank can afford to stay patient.

Turkey has made tremendous progress in controlling inflation

Source: TradingEconomics.com

The Bank pointed to volatility in food and energy prices and to "uncertainty in global markets" as reasons for staying cautious on policy. The Bank also found encouragement in a recent improvement in the current account deficit. My guess is that improvement is more a result of the end of the U.S. dollar's run-up in March than fundamental improvements in Turkey's economy. Until the Bank decides to take decisive action against inflation and/or the weakening currency, I am fine shorting the lira as the main trading strategy.

Be careful out there!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In forex, I am long USD/TRY