Lira Setting up for No Confidence Show

Ankara has found itself in a very delicate set of problems evolving both politically and economically as the region is set ablaze by conflict and heightened uncertainty.  The Lira has once again lost its composure since the downing of the Russian jet, with the Turkish currency looking set to weaken further over the medium-term amid tenuous relationships with allies and rising tensions with other regional power brokers.  In his quest to restore Turkey’s regional hegemony, President Erdogan has nearly brought the economy to its knees alongside the Lira which is forecast to drop further amid the worsening outlook.

Turkish Economy Remains Fragile

The latest fundamental metrics show a nation that is attaining strong growth amid a number of internal and external headwinds.  However, unlike most countries, Turkey has been successful at improving government debt to GDP which according to 2014 stands at 33.0% versus 46.1% as recently 2009.  Nevertheless, the trade deficit remains steadfast despite notable gains and although interest rates have been accommodated substantially to 7.5% from 10.0% back in 2014 only to remain on hold for the last 10-months.  The latest decision contrasted sharply with analysts anticipating that Turkey’s Central Bank would opt to raise rates in tandem with the US Federal Reserve.

With these set of conditions, it has been difficult for the Turkish Central Bank to tackle persistently high inflation and manage to quell the latest round of depreciation in the Lira.  Turkish inflation is notably high, especially in relation to advanced economies, currently sitting at an 8.1% annualized pace.  Price commodity deflation across the globe, the move by the Federal Reserve to raise interest rates has seen an exodus of US dollar investments from across emerging economies, raising funding costs.  From the major credit agencies perspective, the outlook also remains negative with the nation’s credit assessed just barely in investment grade territory.

Internal Conditions Remain Difficult

Domestically, Turkey is dealing with a period of unrest after a runoff election and reelection of President Erdogan has led to the reemergence of deep divisions, especially with the country’s ethnic Kurdish population.  The economy is already contending with difficultly of tackling stagflation a high jobless rate currently standing at 10.3%. While the economy remains in expansionary territory, it must be noted that a substantial proportion of these gains are likely attributable to export competitiveness thanks to a Lira that fell nearly 25.0% versus the US dollar last year alone.

Now that Erdogan has found himself increasingly isolated from his neighbors including Greece and Russia, efforts at reconciling with other regional economies is underway especially as he tries to improve the domestic outlook amid the unrest on national borders.  Sanctions from Russia are something that should not be ignored, especially as a once planned pipeline to bypass troubled Ukraine has now been put on hold in retaliation.  Optimism remains high that negotiations will not be stalled, however, Turkey remains steadfast in its refusal to apologize to Russia for the downing of its military jet.  Rising tensions with Greece over airspace incursions also threaten to downgrade Turkish ties to NATO. 

Further alienation is not desirable especially in the wake of hostilities unfolding in neighboring Syria and Iraq.  In light of the deteriorating domestic financial conditions, Turkey has made known its desire to restore ties and reconcile with Israel.  Despite a downgrade of relations several years back, Israel remains a major transit hub for Turkish exports to make their way on towards the Gulf States.  Trade ties have actually risen over time despite ailing political ties with bilateral transaction growing the last several years.  However, as Erdogan runs short of cash, this upgrade is not going to have a meaningful impact on reversing the underlying political alienation of the Erdogan Government or substantially improve economic conditions. 

The Technical View

The Lira has largely echoed the deteriorating economic outlook with the USDTRY currency pair rising 24.5% in 2015, substantially outpacing the 8.1% rally in the US dollar index over the same time period.  Although the Lira was able to rebound from the sharp losses experienced over the summer, conditions have since begun to reverse once more to the downside for the Lira with the prevailing USDTRY trend resuming.  Evaluating the trend shows that in spite of a recent 40.0% technical retrace lower, USDTRY remains above both the short and longer-term moving averages in a sign that the trend higher is set to persist with both moving averages acting as support levels.

 

The four-hour candlestick chart shows that the USDTRY pair is current trending in an emerging bullish equidistant channel formation.  Ideally, long positions will be established near the lower line of the equidistant channel, focused on targeting the upper line of the pattern.  Short positions should be avoided at the top of the channel because reward potential shrinks while risks stay constant versus a trend following strategy.  Should USDTRY move above or below the channel lines, it could suggest a channel-based breakout to be accompanied by renewed directional momentum.  The target for the coming months remains record highs near 3.0754.

More Pain Ahead

Even though the USDTRY has been consolidating over the past several weeks amid weak seasonal FX trading volumes, political and economic developments threaten to derail any economic progress.  A weak global trade backdrop and strains with other regional powers have left Erdogan largely absent of allies at a time when political conditions are fractious and the economy needs a jumpstart.  The tightening government control over the economy could lead to a further exodus of foreign direct investment and see sovereign borrowing conditions worsen.  As such, the current depreciation trend of the Turkish Lira is unlikely to abate over the medium-term absent a few favorable developments.  Erdogan is only expected to aggravate investor sentiment further with his hegemonic ambitions.

This article was written by Idan Levitov, Head analyst for anyoption.com