TRY: Failed coup in Turkey weighs heavily on the lira - MUFG

Lee Hardman, Currency Analyst at MUFG, suggests that the main market moving event over the weekend has been the failed coup in Turkey which has triggered a temporary squeeze of carry positions that have been built up recently.

Key Quotes 

“The Turkish lira has been the hardest hit currency falling sharply against the US dollar which lifted USD/TRY to an intra-day high on Friday of just over the 3.0500-level after reports of the coup were first announced. It has since rebounded strongly in the Asian trading session reversing over two thirds of its initial losses after the coup proved unsuccessful. The consolidation range for USD/TRY between roughly the 2.8000 and 3.0500 levels which has held since the summer of last year continues to remain in place for now after the top of the range was tested and held.

The broader financial market impact should prove fleeting although it will leave a more lasting impact in Turkey. The lira has suffered two sharp sell offs so far this year and both have been driven by negative political domestic developments. The lira was able to regain a firmer footing after the shock resignation of Prime Minister Davutoglu in May. The developments clearly highlight that political risk remains elevated in Turkey and will continue to be a weight on the lira going forward.                         

Deputy Prime Minister Simsek has attempted to quickly reassure investors in Turkey stating that there is “no need to panic and one has to remain calm”. He sees a rapid normalization and no permanent damage for the Turkish economy which has “solid” macroeconomic foundations. The CBoT has also moved to reassure investors by pledging to take all precautions to protect financial stability including the provision of necessary liquidity to banks limitlessly. It stated that it will closely monitor market and price movements. The CBoT are scheduled to hold their next monetary policy meeting tomorrow. Less stable financial market conditions may now make the CBoT less willing to continue simplifying and modestly easing monetary policy as soon as at tomorrow’s meeting reducing the likelihood that it will lower the overnight lending rate by a further 0.50 percentage point.  

Despite the reassurances from leading Turkish officials, the developments will prompt investors to attach a higher political risk premium to Turkish assets. Initial fears that the failed coup would help to reinforce the ongoing strengthening of President Erdogan’s power and influence appear to be materializing. It has been reported that almost 3,000 members of the military and security have been arrested and more than 2,700 judges dismissed which includes two members of the constitutional court and ten members of the High Council of Judges. It could lead to a further erosion of the country’s checks and balances. President Erdogan could use the failed coup to push through his attempt to change the constitution and create a fully-fledged presidential system. However, Deputy Prime Minster Simsek has already stated that he doesn’t foresee early elections.

Domestic assets will be less attractive making it more challenging to finance Turkey’s still sizeable current account deficit keeping downward pressure on the lira. Still the scope for lira downside may prove more modest than initially feared as the market was already viewing domestic political developments with caution, the lira has already weakened significantly in recent years, and external conditions remain supportive for carry trades in the near-term.”