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

Core Content

This document outlines the current state of the Turkish Lira (TRY) and provides a strategic recommendation for investors based on the analysis of FX rates, ccy curve dynamics, and the Central Bank of the Republic of Turkey (CBRT)'s monetary policy.

Main Points

1. TRY FX Depreciation and Ccy Curve

• The TRY basket (50% USD / 50% EUR) is depreciating faster than the path predicted by the forwards market.
• TRY FX forwards are currently based on a 12%+ premium, indicating market expectations of continued depreciation.
• The ccy curve has steepened due to the demand for hard currency, which is not being fully offset by current interest rates.
• The market is pricing in rate hikes up to 6m and rate cuts beyond 1y, but these expectations have historically not materialized due to CBRT's delayed tightening.

2. Return Synchronisation and FX Sell-off

• Realised forward returns in the TRY basket have turned negative across all time horizons, including 1-week, 1-month, 3-month, and 6-month.
• This synchronised underperformance suggests that investors holding TRY have not been rewarded for funding Turkey's current account deficit, despite rate hikes.
• The pattern of returns indicates a risk of accelerated depreciation unless the CBRT intervenes, which is considered unlikely.

3. CBRT's Knock-in Strategy

• The CBRT historically reacts to currency depreciation rather than proactively tightening policy.
• This "knock-in" strategy leads to delayed monetary tightening, which exacerbates inflation and prolongs FX depreciation.
• The CBRT's inaction has contributed to the downward trend in long-term returns, risking investor confidence.

4. Strategy: Buy USDTRY 3-Month 25 Delta Call Option

• The current strategy shifts from paying 1y1y TRY ccy rates to positioning for a potential burst of dependence in the FX market.
• A USDTRY 3-month 25 delta call option is recommended, with a cost of 1.05% of notional.
• The breakeven is relatively close to the current spot rate (3.85), at 3.92, indicating a low threshold for profitability.
• The strategy is based on the assumption that a burst of dependence could cause a sharp rise in USDTRY, and the market has not yet priced in this potential.

Key Information

• Current spot rate: USDTRY = 3.85
• Profit from 1y1y TRY ccy rates: +40bp
• Implied volatility (3-month): 11%, below the November highs of 15%
• Estimated breakeven for the call option: USDTRY = 3.92
• Estimated notional cost for the call option: 1.05%

Market Dynamics

• The steepness of the ccy curve is not sustainable due to large roll-down costs.
• Increased volatility in forward rates is expected to accelerate spot depreciation.
• The market is currently not pricing in near-term rate hikes, which suggests a lack of confidence in the CBRT's ability to control inflation.

Conclusion

• The TRY is under significant FX pressure, with the ccy curve steepening and forward returns turning negative.
• The CBRT's reactive approach to monetary policy is unlikely to change, leading to continued depreciation.
• A strategic shift to buying USDTRY 3-month 25 delta call options is advised to capture potential acceleration in depreciation, especially if a burst of dependence occurs.

Emerging Markets Strategy Contacts

Legal Notice

• This document is non-independent research and may be subject to conflicts of interest.
• It is a marketing communication and not intended as investment advice.
• It is not a prospectus and does not constitute an offer to sell or issue securities.
• The information is based on public sources and is subject to change.
• No liability is accepted for any loss arising from reliance on the information.

United States Disclosures

• Options: Complex instruments with high risk, suitable only for sophisticated investors.
• ETFs: May include tracking error, currency, and geopolitical risks.
• Convertibles Securities: May not be registered under US Securities Laws and are considered restricted securities.
• Distribution: Limited to institutional investors as per FINRA and SEC rules.

Additional Resources

• BNP Paribas Global Fixed Income Website: www.globalmarkets.bnpparibas.com
• Bloomberg Research: Fixed Income Research BPFR, Emerging Markets Research BPFR, G10 Interest Rate Research BPBS, Market Economics BPEC