• Jan

Long term bearish macro : Turkish lira (USDTRY)

Turkish lira is caught between rock and a hard place, with very little room to navigate for its central bank or the president. Facing a runaway inflation, war with neighbour country, nationalistic leader triggering outside forces on reactionary play, high yields on 10y bonds, lots of external debt denominated in foreign currencies (USD and EUR), unwillingness to push for rate hikes fast enough, slower growth than in previous years, tariffs, bearish correlated exposure to other emerging market countries etc etc...


There are many factors currently putting pressure on Turkish lira in internal and external currency markets. Hyper-inflationary crises are one of the strongest and worst economic events because majority of short term wealth in that country is evaporated once the liquidity dries up and the final stages of crisis begin to unfold. Currently Turkey is on its way towards potential highly inflationary scenario, as the history notes the countries that do not change the course quick and strong tend to face the liquidity / inflationary crisis. Often such crisis is triggered by un-ability to pay for short term debts where the country is forced to increase external currency denominated debts in order to pay for long term debts that it cannot afford to finance directly, which is currently unfolding inside Turkey.





Turkish debt has recently been downgraded to status "junk", boxing the central bank along with the monetary and debt policy of country even more. To think that Turkey might default is not out of question, in fact it has defaulted , many times over past 100 years, with average default span of 10 -15 years. Defaults of countries usually seem un-imaginable until the reality hits everyone and it becomes obvious. There is no doubt on the market side that forces for such event are aligned, from the weakening currency, to increasing external debts, to tariffs which are all historically a recipe for default or inflationary crisis. When country defaults on internal debt (often not needed) it is not a big problem, but when its done on external debt it yields huge problems as international markets lose faith to lend to such country. Since emerging market countries are heavily connected in trade, default of one could have spill on effect to other emerging market countries, especially the institutions that own such debt.


The question remains is default more likely than inflationary crisis? Based on the amount of external debt to which its not easy for country to default chances are that inflationary crisis is more likely to unfold, and in fact all the factors for it are already active with inflation hitting new all time highs since last 20 years in Turkey.



Bellow is chart of Turkeys external debt.

Looking at broader historical context, a lot of countries with 40% of external debt to GDP do default. Generally central bank should be increasing interest rates in inflationary environment, but in case if that country is highly in-debted it might not be possible and to make things worse Turkeys president has noted many times that central bank should have or aim for policy with lowering interest rates, which markets interpret as weakness and without surprise push lira lower. When it comes to leading country on market side (country that is globalized and has currency / debt traded globally) is that good strategic leader will only disclose the most needed information and usually positive informations are forwarded into public, while keeping anything negative as a secret (in macroeconomics), and let the markets figure out that information. Disclosing information that central bank should have lowered interest rates policy is bad strategic move, because that in fact central bank cannot do, but with saying that publicly one is admitting that there is also not much room on hiking rates upwards. It basically adds fuel to the fire.


In the end central bank is more or less independent no matter what president says, because reactionary moves have to be taken once the currency slide gets too serious, but it does put additional pressure to have president jumping in between with unrealistic suggestions.


Inflation



While high inflation might not be big problem if economy is growing very fast, inflation rate above 10% will almost never be able to be matched by economic growth (especially not long term).

Inflation will eventually start building up exponentially with year by year if not taken under control and become problematic once the GDP growth rates start to cool down.


Bellow is chart of Turkey inflation rate over few years.

Bellow chart of Turkey inflation rate over 1 year, hitting 25% similar to Russian rubble in 2014 when in the middle of Oil price shock.



How to play it


Since this is very long macro play, it is important to have realistic time horizon while playing it. Trader should hold such trades for larger targets liquidating position in many chunks. Large liquidation events are never priced in fully ahead of time as majority of market participants have more bullish and positive bias towards each economy, therefore each smaller macro play will further and further price that assets towards more realistic pricing until the liquidation event is overdue.


The way i prefer to play those macros is to always wait for strong momentum to kick in (with fresh catalyst that is aligned in direction of larger macro) and then wait for consolidated accumulation setup for entry. Once the consolidation is broken with decent volume and new high that is trigger for long.


Or to keep it with simpler words:

-wait for some short term catalyst to kick in ( new tariffs on Turkey, central bank rate cuts...)

-wait for strong bullish momentum to kick in on USDTRY (bullish for dollar, bearish for lira)

-wait for consolidation and accumulation with lower highs

-long on new higher high, prefered with solid volume


If all 3 variables are included and trader waits patiently for them to set up, the need for very accurate macro analysis decreases, because the overall edge on trade increases. Often its hard to be accurate on time with such macro plays, that is why using the above approach with help of specific market conditions and structural play helps for better accuracy.


Currency defense




Usually when the currency of country drops very quickly in large move, such as it was last year on Turkish lira, the central bank will step in to protect the capital outflows by increasing the interest rates. In most cases central bank will delay the hiking (if it cannot afford a lot higher rates), to wait for one of moment and pull emergency rate hike, which shows sign of strength and confidence. Such a move that TCB took, with huge rate hike.


Bellow emergency rate hike on chart:




Why is the data above important, it is because in most historical cases the currency defense with the emergency rate hiking lasts only around 6 months on average (as country cannot afford to hold such high rates for longer time), and after those initial 6 months in most cases the central bank will start to ease the policy, which in turn pushes up inflation and international capital out of the country, which effects currency bearishly. That is why after those initial 6 months, the currency will start to weaken again over period of next few years.


This data can help trader to structure the higher / longer macro and what to expect on USDTRY FX asset.


And that is why it is not a surprise that just few months ago, Turkish central bank started to cut the rates and the currency responded instantly with drop. Potentially more cuts will be delivered over next 1-2 year period, until the currency starts to drop aggressively again and the TCB is again forced to pull emergency hike. The only question remains, how much room does TCB has on hikes, and how much higher can rates really go from 15% while the currency hits new lows? With the amount of external debt, one thing is for sure, TCB cannot afford to hold rates high for a long time.


Additionally war with Syria only adds fuel to the fire on Turkish lira, as the international markets pull capital away from the country.




London - Istanbul opening overlap (micro)



One good micro patterns that can be used to initiate trades is the opening overlap between London and Istanbul. Often at that cross open the Lira will drop if large macro play is on.

Range break and then push on USDTRY for long play, those are frequent and since the moves are usually very one directional it gives good RR overall. Time window is 9:00 GMT+1 .









The micro pattern for entry above is relatively easy to learn and can be good traded pattern for less experienced traders. This is just an example of micro, but there are many different ways that trader could approach this, in the end the most important thing is to understand macro correctly to find the overall direction.



Shorting USDTRY for overnight fees (DONT)



One thing that one can notice a lot in FX trading communities is that many traders who do not understand fundamentals , they short the USDTRY with overnight positions, because they are paid overnight carry fees just to have position open. This is extremely dangerous, and most traders that played it that way ended with blown up accounts over last 1 year as the Lira collapsed. In trading when things are too good to be true, they usually are. If it was so easy to just have position opened and get free cash into your account with carry fees, then chances are that there is some long term game set against that, which it is.

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