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Summary of EM Strategy Desknote: Turkey - TRY Running Out of Options

Core Content

This document provides an analysis of the Turkish Lira (TRY) and outlines the current FX and interest rate outlook, focusing on the implications of a steepening ccy curve and the potential for accelerated depreciation. The authors, Piotr Chwieczak and Sai Ulluri from BNP Paribas London Branch, present their strategic recommendations for investors in the context of a deteriorating TRY situation.

Main Points

• TRY FX Depreciation: The TRY basket (50% USD / 50% EUR) is depreciating faster than expected based on current forward rates, indicating that the ccy rates are not sufficient to offset the demand for hard currency.

• CCY Curve Steepness: The ccy curve is steep, with a 12%+ premium embedded in the forward rates. This steepness is a reaction to the depreciation and is intended to slow it down, but it is not sustainable due to large roll-down costs.

• Market Expectations: The market has priced in rate hikes between 6m and 1y, but rate cuts beyond 1y are also anticipated. However, these expectations have not materialized in the past, leading to continued inflationary pressures.

• CBRT's Knock-in Strategy: The Turkish Central Bank (CBRT) historically tightens monetary policy only after the currency has already depreciated significantly, rather than pre-emptively. This strategy is described as a 'knock-in' approach, which may not be effective in curbing the current depreciation trend.

• Risk of Accelerated Depreciation: The authors highlight that the current level of returns on TRY is not sufficient to compensate investors for the risk of funding the current account deficit. This could lead to a synchronized underperformance across time horizons, increasing the likelihood of a 'burst of dependence' and further depreciation.

• Volatility and Uncertainty: With uncertainty about future rate hikes, the forwards market is experiencing increased volatility. This volatility is expected to accelerate the depreciation of the TRY spot rate.

• Investment Strategy: The authors recommend buying a USDTRY 3-month 25 delta call option at a cost of 1.05% of notional value. This strategy is intended to capture potential acceleration in TRY depreciation. The breakeven point for this option is relatively close to the current spot rate, indicating a favorable risk-reward profile.

• Market Conditions: Despite early signs of stress, the market has not yet priced in rate hikes in the very short term (next 3 months), and implied volatility remains low. This suggests that the market is not fully anticipating a potential drawdown in TRY.

Key Information

• Current TRY Spot: 3.85
• 1y1y TRY Ccy Rates Payer: 13.60% (profit of +40bp)
• Implied Volatility (3m): 11%, below November highs of 15%
• Breakeven Point (3m Call Option): USDTRY at 3.92, just 1.5% above current spot
• Recommended Strategy: Buy USDTRY 3-month 25 delta call option for 1.05% of notional

Strategic Implications

• The steepening of the ccy curve is a defensive measure but may not be sustainable.
• The current strategy is to position for a potential acceleration in TRY depreciation, rather than continuing to pay ccy rates.
• The authors believe that the market is not yet pricing in a significant drawdown, making the call option an attractive early-stage investment.
• There is a risk that the CBRT will not take preemptive action to stabilize the currency, leading to further depreciation.

Contacts

• Strategists:

  • Piotr Chwieczak: FX & IR CEEMEA Strategist, BNP Paribas London Branch
  • Sai Ulluri: FX & IR CEEMEA Strategist, BNP Paribas London Branch
  • Wike Groenenberg: Head of Emerging Markets Research, CEEMEA & APAC
  • Marcelo Carvalho: Head of Emerging Markets Research, Latam
  • Erkin Isik, CFA: FX & IR CEEMEA Strategist, Turk Ekonomi Bank A.S. (Istanbul)
  • Mirza Baig: Head of FX & IR Asia Strategy, BNP Paribas Singapore Branch
  • Gabriel Gersztein: Head FX & IR Latam Strategy, Banco BNP Paribas Brasil S.A. (Sao Paulo)
  • Samuel Castro: FX & IR Latam Strategist, Banco BNP Paribas Brasil S.A. (Sao Paulo)
  • Gustavo Mendonca: FX & IR Latam Strategist, Banco BNP Paribas Brasil S.A. (Sao Paulo)

• Production:

  • Barbara Consuelo: London, BNP Paribas London Branch
  • Amanda Grantham-Hill: London, BNP Paribas London Branch
  • Anna McLauchlin: London, BNP Paribas London Branch
  • Varghese Joseph: New York, BNP Paribas Securities Corp (New York)

Legal Notice

• This document is non-independent research and may be subject to conflicts of interest.
• It is intended for Professional Clients and Eligible Counterparties under MiFID II.
• It does not constitute an offer to sell or issue securities.
• The information is for informational purposes only and not intended as investment advice.
• All estimates and opinions are subject to change without notice.
• The document may contain simulated performance data and is not a prospectus or public offering.
• BNPP may have financial interests in the securities discussed and may engage in transactions inconsistent with the views expressed.