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Turkey's Lira Plummets to Record Low as New Cabinet Looms

Concerns mount over the sustainability of unorthodox policies as speculation arises about potential changes.

Turkey's lira suffered a significant blow on Wednesday, hitting a fresh record low against the US dollar as President Tayyip Erdogan prepared to shape his new cabinet and steer the nation's economic policies following a triumphant election outcome. This marked the third consecutive day of losses for the lira, as it weakened by nearly 1.5% to reach a historic level of 20.75 against the US currency, pushing its losses for the year to nearly 10%.

USD/TRY Bar chart showing forex and commodities prices, green/red candles depict daily trading trends. Includes moving average, Bollinger bands, and RSI.

Investors have grown increasingly anxious about the viability of Turkey's unorthodox economic policies, which have been championed by President Erdogan and centred around a low-rate program. Now, all eyes are on the appointments to top economic policymaking roles, as market participants eagerly anticipate any indications of a potential shift towards more conventional economic measures.

A recent meeting between President Erdogan and Mehmet Simsek, a former economy chief known for his orthodox policy credentials, has fuelled speculation regarding a possible pivot to more conventional policies. While it remains uncertain whether Simsek will become the new finance minister, experts stress the importance of appointing credible figures to signal the market that change is imminent. "If you have Mehmet Simsek or a similar person in charge, that is a big move. But then the market will be curious about the first move of the economic team – will there be more orthodox policies or will they do something worse or will they do something to buy time and see how it goes?" said Cagri Kutman of KNG Securities.

Despite various challenges, including southern earthquakes, high inflation, and a cost of living crisis, Turkey's first-quarter economic growth remained buoyant. Official data released on Wednesday showed that the economy expanded by 4.0% in the first quarter of the year, slightly surpassing expectations. This growth was achieved despite the devastating impact of February's earthquakes, which claimed the lives of more than 50,000 people and displaced millions.

Nevertheless, signs that President Erdogan may be loosening his grip on the currency market following his re-election have led to sharp declines in the lira, a trend not observed for almost a year. Since the beginning of May, the lira has weakened by approximately 6% and reached a new record level above 20 against the US dollar this week. The currency's historical volatility surged from 3% to 19% before the first round of elections in mid-May, and Bloomberg predicts that implied volatility in the lira will exceed that of all other major currencies in the coming months.

Previously, the Turkish central bank kept the lira under close control through daily backdoor interventions and emergency measures as part of Erdogan's campaign to ensure stability in the exchange rate, a factor closely watched by Turkish voters ahead of general elections. With Erdogan's victory now secure and his party holding a firm majority in parliament, analysts argue that the costly micro-management is no longer necessary.

Gordon Bowers, a London-based analyst at Columbia Threadneedle Investments, suggests that the focus will shift away from defending a specific exchange rate level as observed before the elections. Bowers believes that given the anticipated current-account surplus during the summer months, there is potential for more two-way trading. While the central bank has successfully fended off lira depreciation through emergency measures and interventions, this policy has rendered the lira the dullest currency among emerging markets over the past six months. However, the costs have accumulated, with authorities spending nearly $200 billion in the past year and a half to support the lira, leading to negative net foreign-exchange reserves at the central bank.

The substantial current-account deficit, which stood at $4.5 billion in March, and the burden of foreign debt paint a grim outlook for the Turkish currency. Traders are now considering the possibility of changes to Erdogan's unconventional economic model, fuelled by growing expectations that market-friendly former finance minister Mehmet Simsek will return to the administration to assist in guiding the economy.

Sergey Dergachev, the head of emerging-market corporate debt at Union Investment Privatfonds GmbH in Frankfurt, expressed hope that the government will take the first steps toward adopting orthodox monetary policies. However, analysts caution that while the lira's recent decline suggests a decreased emphasis on foreign-exchange interventions by state banks, it does not necessarily indicate a complete normalization or increased foreign investor influx. The remainder of the year presents a challenging outlook for Turkey's economy, as Erdogan contends with a cost-of-living crisis.

The composition of Erdogan's economics team and their initial policy response will play a crucial role in attracting foreign investment back to Turkey, according to analysts at Citigroup Inc. While prospects for a return to conventional policies may seem less promising under Erdogan's firm leadership, Citigroup analysts, including Luis Costa, highlight the mounting challenges the central bank will face in maintaining deeply negative interest rates, adjusted for inflation, starting from the last quarter of the year.

For traders, the current state of Turkey's lira presents both risks and opportunities. The lira's recent record low against the US dollar and its heightened volatility indicate a market in flux, driven by uncertainties surrounding the composition of Erdogan's new cabinet and the direction of economic policies. Traders should closely monitor the appointments to key economic positions, particularly the finance minister, as this will provide valuable insight into the potential course of action.

Speculation regarding a shift towards more orthodox policies, as signalled by the meeting between Erdogan and Mehmet Simsek, has created hopes among investors. If the government demonstrates a commitment to conventional economic measures, it could instil confidence and potentially lead to a stabilization of the lira.

However, caution is advised as the challenges facing Turkey's economy remain significant. The country's high inflation, cost-of-living crisis, and large current-account deficit pose ongoing risks. Traders should closely evaluate the credibility and effectiveness of the government's initial policy response and monitor indicators such as GDP growth, inflation rates, and foreign exchange reserves to gauge the trajectory of the lira.

Given the lira's recent slide and the potential for increased two-way trading, traders may find opportunities in short-term fluctuations and volatility. However, it is crucial to exercise careful risk management and closely follow developments in Turkey's economic and political landscape.

Overall, the coming months will likely be critical for the lira and Turkey's economic outlook. Traders should remain vigilant, stay informed about policy announcements and economic data, and adjust their strategies accordingly to navigate the evolving market conditions.


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