Bye Bye TRY

The Turkish lira remains the primary FX casualty in this risk-off environment. Not blind, unbridled EM selling, but select liquidation of currencies with clear faults. Turkey, with a heavy USD dominated debt load, has failed to play by international investors’ rules and is now facing the devastating consequences. The Turkish lira dropped to its weakest level as the White House indicated the US would impose sanctions on two ministers of the Turkish government who were involved with the false detention of Pastor Andrew Brunson.

The Turkish stock market is the world’s worst performer in local currency, bond yields have hit a record high and the lira has dropped around 25% against the greenback this year. Last weeks sanctions aggravated a situation where President Erdogan has suggested the removal of the central bank’s independence. Without policy control the Central Bank of Turkey has been unable to address surging inflation. This failure of correct governance has triggered investors’ sustained rush to the exits.

The deadly combination, of a puppet central bank and out of control inflation, sent USDTRY above 5 for the first time ever. Perhaps the lira’s only saving-grace was the July inflation came in slightly lower than expected at 15.85% verse 16.30% (yet still above June’s read). Erdogan’s meddling in CBT policy prevents the bank from taking critical action to slow accelerating prices. Erdogan has sacrificed price stability by stopping the central banks from raising rates in order to stimulate economic growth. Incredibly, Turkish interest rates at 17.75% have been too low to halt the mass exodus (real rate a paltry 1.9%). Is the lira collapse over? Doubtful. The CBT would have to raise rates right now (not at September meeting) 3-5%. Interest rates at 20% would all but kill the Turkish economy: Erdogan is unlikely to let that happen.