USDTRY Short After Surprising Rate Hike on Sept 24, 2020
After a series of stealth measures by the central bank to contain the lira's weakness: such as ceasing to provide funding at its cheapest benchmark rate which began in August, Gov Uysal increased the benchmartk one-week repo rate to 10.25% from 8.25% on Sept 24, 2020. He assessed that such tightening steps should be reinforced with the rate hike to contain inflation expectation and risks to the inflation outlook.
Back on August 10, 2020, Gov Uysel took a measure to raise the cost of money for its primary dealers (firms that trade directly with the Turkish central bank) which had already experienced a halve of their liquidity limits. The decision was made to increase the weighted average cost of funding. This type of stealth tightening was seen by the market as flexible and temporary, which is why we saw a sharp depreciation of the lira until now coupled with the recent strength this week of the USD as equities liquidity gets into it. The market needs to believe that the central bank will keep policy tightened for an extended period. With the base rate being increased now, this also means there was a huge waste of FX reserves as Turkey state-owned lenders sold dollars to support the lira.
Why tightening might ease the inflation outlook and strengthen the lira?
1. The benchmark 1-week repo rate stands now at 10.25% which is still BELOW the bank's weighted average cost of funding which stands at 10.65% currently.
Risks:
A. We do not know the full extent of the tightening: If policymakers still refuse to provide funding to its commercial banks at the 1-week repo rate of now 10.25% and instead redirects them to borrow at their late liquidity window rate which is its highest rate at 13.25%.
B. President Erdogan appeals for lower borrowing costs. In Turkey the president has the power to fire the head of the central bank so it is possible that the rate hike is done to increase bullish sentiment on the lira while still playing around its rate corridor which goes from 13.25% for the late liquidity rate, to 10.25% for the 1-week repo rate. Gov Uysal could be playing politics with the rate tightening and easing which would be a repetition of what has been happening ever since the beginning of August 2020.
C. Geopolitical risk: EU Summit was posponed to 1-2 Oct, 2020. During this summit, EU leaders were going to discuss imposing potential sanctions on Turkey, but on Sept 24, Greece and Turkey agreed to diplomatic talks making the probability of sanctions very unlikely.
Counter-argument for risks:
A. Gov Uysal performed the rate hike from 8.25% to 10.25% as a measure to start giving back its commercial banks the option to borrow at their lowest benchmark rate. Banks had the only option of borrowing at the previous late liquidity window rate of 11.25% so the rate hike could be viewed as a way to encourage investors and banks to hold the nation's asset.
B. Most economists and central bankers believe that lower rates cause inflation as capital outflows increase since investors are demanding higher returns for holding the lira as a risky asset. Higher rates compensates investors for the risk and would strengthen the lira easing borrowing cost pressures on the central bank's own obligations. This would avoid a potential balance of payments crisis.
Technical analysis:
After price broke from the trendline, once the rate hike decision was made, price dipped with more buyers showing up after bouncing on the 4HMA. This leads me to believe there is a consolidation to happen over the coming days and possibly weeks before we see price initiating a bearish trend. This could be the result of investors waiting to see that the Turkish central bank is serious about providing higher rates and as investors start getting attracted to the higher return on their money for holding the lira. For this the horizon on this trade is of around 3 weeks.
Stop loss level has been placed at 7.71687 which is a 200 points risk, give or take since this pair counts points differently.
TP1 is at 6.68000
TP2 is at 6.42169
Will continue to monitor future geopolitic and economic events as they develop.
Back on August 10, 2020, Gov Uysel took a measure to raise the cost of money for its primary dealers (firms that trade directly with the Turkish central bank) which had already experienced a halve of their liquidity limits. The decision was made to increase the weighted average cost of funding. This type of stealth tightening was seen by the market as flexible and temporary, which is why we saw a sharp depreciation of the lira until now coupled with the recent strength this week of the USD as equities liquidity gets into it. The market needs to believe that the central bank will keep policy tightened for an extended period. With the base rate being increased now, this also means there was a huge waste of FX reserves as Turkey state-owned lenders sold dollars to support the lira.
Why tightening might ease the inflation outlook and strengthen the lira?
1. The benchmark 1-week repo rate stands now at 10.25% which is still BELOW the bank's weighted average cost of funding which stands at 10.65% currently.
Risks:
A. We do not know the full extent of the tightening: If policymakers still refuse to provide funding to its commercial banks at the 1-week repo rate of now 10.25% and instead redirects them to borrow at their late liquidity window rate which is its highest rate at 13.25%.
B. President Erdogan appeals for lower borrowing costs. In Turkey the president has the power to fire the head of the central bank so it is possible that the rate hike is done to increase bullish sentiment on the lira while still playing around its rate corridor which goes from 13.25% for the late liquidity rate, to 10.25% for the 1-week repo rate. Gov Uysal could be playing politics with the rate tightening and easing which would be a repetition of what has been happening ever since the beginning of August 2020.
C. Geopolitical risk: EU Summit was posponed to 1-2 Oct, 2020. During this summit, EU leaders were going to discuss imposing potential sanctions on Turkey, but on Sept 24, Greece and Turkey agreed to diplomatic talks making the probability of sanctions very unlikely.
Counter-argument for risks:
A. Gov Uysal performed the rate hike from 8.25% to 10.25% as a measure to start giving back its commercial banks the option to borrow at their lowest benchmark rate. Banks had the only option of borrowing at the previous late liquidity window rate of 11.25% so the rate hike could be viewed as a way to encourage investors and banks to hold the nation's asset.
B. Most economists and central bankers believe that lower rates cause inflation as capital outflows increase since investors are demanding higher returns for holding the lira as a risky asset. Higher rates compensates investors for the risk and would strengthen the lira easing borrowing cost pressures on the central bank's own obligations. This would avoid a potential balance of payments crisis.
Technical analysis:
After price broke from the trendline, once the rate hike decision was made, price dipped with more buyers showing up after bouncing on the 4HMA. This leads me to believe there is a consolidation to happen over the coming days and possibly weeks before we see price initiating a bearish trend. This could be the result of investors waiting to see that the Turkish central bank is serious about providing higher rates and as investors start getting attracted to the higher return on their money for holding the lira. For this the horizon on this trade is of around 3 weeks.
Stop loss level has been placed at 7.71687 which is a 200 points risk, give or take since this pair counts points differently.
TP1 is at 6.68000
TP2 is at 6.42169
Will continue to monitor future geopolitic and economic events as they develop.
Trade active:
Correction:
Stop loss level has been placed at 7.82113 which is a 200 points risk, give or take.
Stop loss level has been placed at 7.82113 which is a 200 points risk, give or take.
Soft Brexit deadline on October 15, 2020 could provide for a temporary bullish move on USD in the form of safe-haven that could be an opportunity for addition of position.