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Turkish lira a rare bright spot for emerging market currencies in July

Turkish lira updates

The Turkish lira has clawed back part of its steep decline from earlier in the year in recent weeks, bucking the trend in a bruising period for emerging market currencies.

The currency has ticked higher as investors tiptoe back into Turkey’s lira-denominated bonds, amid relief that the central bank has not bowed to pressure from president Recep Tayyip Erdogan to cut interest rates despite surging inflation. The lira is up 3 per cent against the dollar in July — its first monthly rise since January — making it by far the best-performing of the major emerging-market currencies against a resurgent greenback.

The tentative signs of stability follow a collapse in the currency in March after Erdogan fired the central bank governor, replacing him with Sahap Kavcıoglu, who shares the president’s unconventional view that raising interest rates fuels rather than tames inflation. Despite the change in leadership, interest rates stayed on hold at 19 per cent earlier in July for the fourth straight month after inflation accelerated to 17.5 per cent in June. 

On Thursday, as the central bank hiked its year-end inflation forecast to 14.1 per cent from 12.2 per cent, Kavcioglu reiterated his pledge to maintain tight monetary policy and keep the benchmark interest rate above inflation “until strong indicators point to a permanent decline in inflation and the medium-term 5 per cent target is reached”.

Yet he said he expected inflation would “decrease significantly in the last quarter of the year”, something analysts say could pave the way for a rate cut in coming months.

“For the lira, no news is good news,” said Viktor Szabo, a portfolio manager at Abdrn. “Following some of Erdogan’s comments recently, there was a fear that would translate into rate cuts.”

Still, the currency remains 12 per cent lower against the dollar this year, having fallen dramatically out of favour with overseas investors. “It’s doing well recently because it has done so badly,” said Szabo. “There’s no one left to sell it.”

Prior to Turkey’s currency crisis in 2018, foreign investors held more than a fifth of Ankara’s local currency debt. That figure collapsed to 3 per cent late in 2020 but has edged higher this year despite the changes at the central bank, hitting 6.7 per cent in early July, according to the most recent figures from the central bank. As long as the currency remains stable, 10-year yields as high as nearly 17 per cent are tempting to foreign buyers.

The lira’s performance puts it out of step with other major emerging currencies such as the South African rand and Brazilian real, which have notched up strong gains this year but have fallen back somewhat since Federal Reserve forecasts last showed that some officials are contemplating rate rises as early as next year. The prospect of monetary tightening from the US central bank arriving sooner than previously anticipated has boosted the dollar against a broad range of currencies.

Some investors are doubtful the lira’s reprieve will last. Marcelo Assalin, head of emerging market debt at William Blair said the firm has made “tactical” bets on Turkish local currency debt in recent months. “We have been long a couple of times but always with a very short-term view,” he said. “There’s a significant risk that once inflation stabilises we see material interest rate cuts. The problem is always the way monetary policy is conducted.”

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