Turkish Lira Responds to Rising Fiscal Challenges
As Turkish Prime Minister Recep Tayyip Erdogan’s administration completes its purge following the attempted coup over the summer, the success in eradicating his opposition has largely hidden the growing fiscal problems that have resulted. Slowing business activity, weak tax collections, and a new foreign military engagement are all conspiring to hurt economic activity at a time when the government can ill afford another setback.
While plans to increase government spending have been largely well-received by analysts and rating agencies, growth is expected to remain well below the 5.00% threshold for years to come. Now that additional rate cuts are forecast as the government ramps up efforts to spend its way out of a slowdown, the Lira has been on a rapid slide, falling to a new record low versus the US dollar on Friday. With no end in sight for difficulties, the losses may persist as the economy gets little relief.
Setbacks For Key Turkish Industries Remain
Although conditions in Turkey have normalized to a degree following the thwarted takeover attempt, the country is facing pressure from every side. A rising frequency of domestic terrorism combined with an evacuation of US diplomatic staff has created a difficult environment for Turkey’s critical tourism industry. Besides tourism, the volatile political environment has caused business activity to slow noticeably. Value-added taxes, which account for nearly one-fifth of the government tax base, have seen collections cut in half as businesses and households struggle to rebound from the ongoing crackdown.
As a result of the slowdown, the government’s predominant response has been to increase spending, with the Finance Ministry forecasting a deficit until 2019 at the very earliest. Aside from responding with fiscal stimulus, the other rout that is being explored is additional monetary stimulus. Although the Central Bank refrained from cutting rates during its October meeting, expectations are for one rate cut before the end of the year and another during the first half of 2017. The one item that might prevent additional accommodation is inflation, which at 7.28%, remains well above the 5.00% targeted by the Central Bank. The institution recently revised its own estimates, projecting 6.50% during 2017 and stabilization at 5.00% by 2018.
Stimulus Has Its Limits
With fiscal stimulus likely to show limited by firepower, the real ammunition lies in interest rates. As such, rising speculation of another rate cut over the near-term has seen the Turkish Lira sink to record lows against the US dollar. While partially attributable to recent dollar momentum higher on the back of rising interest rate hike speculation, Turkish fundamentals are assuredly not helping. The problem for Turkish officials is circular in nature. Simply put, expectations of future rate cuts are hurting the Lira. The weaker Lira is causing inflation to remain above target and while inflation is above target, the Central Bank is unable to accommodate further to spur growth. The result is a situation in which policymakers are officially stuck with several unattractive policy options.
Should officials lower rates before inflation falls to more reasonable levels, the resulting loss in the Lira could cause runaway inflation that damages the outlook the private sector and erodes personal income. As such, the best option right now is for the Central Bank to ride out higher inflation with the expectation that the Lira will continue to lose ground, especially if the Federal Reserve opts to raise rates during December. Furthermore, a decision to define a more structured timetable for future rate increases could send the USDTRY pair even higher. As such, medium-term risks are stacked against the Lira unless a miraculous turnaround manifests itself in the economy.
Looking at the USDTRY from a technical vantage point, several striking factors begin to emerge. For one, the recent break to new record highs puts the pair in unchartered waters. The pair recently managed to cross longstanding resistance ranging from 3.0572 to 3.0960 that formed the upper bound of an ascending triangle pattern. The consolidation is formed by the upward trend line that has remained unbroken since 2014. However, the rally is showing on limited momentum, indicating that a retest of the breakout level is highly likely. Nevertheless, considering the upside is supported by multiple moving averages, a pullback towards support could be viewed as a strong entry point for bulls.
Potentially fueling additional USDTRY gains is the bullish moving average crossover that occurred over the summer. Since then, the 200-day moving average has largely held up against bearish price action from USDTRY. Furthermore, a closer look shows an emerging head and shoulders bullish pattern forming over the last year. With the right shoulder largely completed, the key just remains a break above the upper bound near 3.1120. On the downside, a retest and break below the shoulder line could be a sign the momentum higher is over and the pattern is breaking down. However, standing in the way of any progress are the moving averages which are acting a support.
This week’s FOMC decision and payroll outcome will be critical to USDTRY momentum going forward. With the downside risks for Turkey’s outlook outweighing the upside potential, the Lira has few catalysts for a rapid appreciation. The dollar on the other hand, could find itself surging higher if a more defined time line for raising rates is announced or even hinted at. Any feather in the Fed’s cap between now and December is likely to raise the prospect of a tightening cycle. Should it materialize, the US dollar rally against the Lira may well be in its early stages. Until then, USDTRY price action will likely be range bound until Wednesday’s decision. However, expect explosive momentum if the Federal Reserve drops a bombshell on markets.