While it’s not the most widely followed currency pair, the USD/TRY has certainly formed one of the strongest downtrends in the forex market over the past three weeks. It seems like a lifetime ago that bearish traders forced the Central Bank of the Republic of Turkey (CBRT) to hike interest rates an unprecedented 425bps to stem the relentless selling pressure. Now the pair is trading at a new 2014 low, down 13% from its January high, and working on its 11th consecutive bearish close.
From a fundamental perspective, this move has been driven by a confluence of factors. One major driving force has been the persistently high inflation in the country. Just on Monday, the widely-watched CPI report came out hotter-than-expected at 9.4% YoY, vs. expectations of just 8.9%; this reading represented the highest inflation rate the country has seen in two years.
The rise in inflation is broadly seen as temporary, but it suggests that the CBRT will keep interest rates elevated in the near-term. Another factor in play is the ongoing tension between the CBRT, which prefers tighter policy to fight inflation, and the Turkish government, which would prefer the bank to cut interest rates to stimulate the economy further, especially ahead of the upcoming presidential elections in August. After the disastrous impact of the CBRT’s decision to bow to government pressure earlier this year, the bank may be “once burned, twice shy” about loosening policy prematurely.
Interestingly, the market’s expectation for elevated short-term rates but falling longer-term rates has led to an inverted yield curve (where the 2-year bond has a higher yield than the 10-year bond). These rare situations typically do not last for long and are associated with higher volatility in exchange rates, so lira traders are encouraged to stay nimble over the next couple of weeks.
The final primary factor driving the lira higher is the perception of receding geopolitical risk in the surrounding region. Yesterday, Russian President Vladamir Putin announced that he had withdrawn troops from the Ukrainian border, lowering the risk of military action in the embattled country. That said, NATO officials noted that there was no evidence that the promised withdrawal had taken place, so those comments may represent merely the latest salvo in an ongoing “war of words.”
As we noted above, the USD/TRY has is working on its 11th consecutive bearish day on the back of these fundamental catalysts. Though rates broke conclusively below the 200-day MA yesterday, the pair is nearing a critical area of converging support around 2.07. This area represents previous-resistance-turned-support from the August 2013 highs, as well as the 50% Fibonacci retracement off the February 2013 lows.
Given the strong downtrend over the past three weeks, the pair is deeply oversold on a variety of measures. Both the widely-followed RSI and Slow Stochastics indicators are trading in oversold territory (< 30 and < 20 respectively) and the last time these indicators hit such an extreme level (early April), the USD/TRY rallied 650 pips over the next two weeks, though of course there’s no guarantee we’ll see a similar bounce this time.
If we do see a near-term floor form, the USD/TRY’s first hurdle will be the 200-day MA around 2.09, followed by the Fibonacci retracements of the recent drop (not shown), starting at 2.10. Meanwhile, a conclusive break below key support at 2.07 would be a very bearish sign for the pair, and traders will start to look for that critical level to provide resistance moving forward.