Turkish Lira Swings After Its Biggest Rally in 38 Years

(Bloomberg) — Turkey’s lira swung wildly after rallying nearly 50% this week, as investors weighed the sustainability of government measures to shore up the currency.

The lira fell 7% after soaring as much as 20% against the U.S. dollar earlier on Tuesday. The whipsaw trading has made the currency the world’s most volatile, with a gauge of expected swings over the next year at a record high, showing traders are betting on more drama throughout 2022.

The currency rocketed Monday in the biggest rally since 1983 after President Recep Tayyip Erdogan’s government said it planned measures including the introduction of a program to protect savings from the lira’s fluctuations. The government will make up for losses incurred by holders of lira deposits should its declines against hard currencies exceed interest rates promised by banks, Erdogan said.

“It may signal that the worst is over for the lira for now, if the program can restore some of the confidence of retail lira depositors,” said Todd Schubert, head of fixed-income research at Bank of Singapore Ltd. “However, at the end of the day, until interest rates provide a credible anchor against inflation, the lira will tend to be volatile and subject to downward pressure.”

The lira was trading around 3% higher at 12.9643 per U.S. dollar as of 12:30 p.m. in Istanbul. The country’s benchmark Borsa Istanbul 100 Index slid 5% to trigger a market-wide circuit breaker for a third day in a row. Companies with foreign-currency income, including the steelmaker Eregli Demir ve Celik Fabrikalari TAS and the glassmaker Sise ve Cam Fabrikalari AS, led the declines on Tuesday.

Gyrations in the Turkish lira have sent the dollar-lira pair’s three-month volatility to 53%, surpassing levels during a currency crisis in 2018. The country’s bonds have also been rocked, with the yield on 10-year government notes down 90 basis points, the most since April.

The government’s new measures are intended to mitigate retail investors’ demand for dollars and bring an end to three months of turmoil for the nation’s currency. But just how local investors react — and whether the new policies are sustainable — remains to be seen.

Turkey’s five-year credit default swaps fell by 35 basis points to 589 basis points, though still hovered near the highest level in more than a year, signaling investors harbor concerns over the nation’s debt-repayment capability.

Read More: How Erdogan’s Unorthodox Views Rattle Turkish Markets: QuickTake

Erdogan’s announcements “could help the currency, but I think it comes down to credibility and whether depositors believe that’s a policy that can actually be implemented,” said Brendan McKenna, a currency strategist at Wells Fargo in New York. “Right now, Turkish institutions don’t have a ton of credibility, so there may be challenges getting lira depositors on board.”

Turkey’s currency has been battered for years as Erdogan has assumed a tighter hold over the economy and turnover at the top of the central bank has intensified. The Turkish leader is heading toward general elections in 2023, the first since his shock defeat in the 2019 municipal vote, which saw Istanbul and Ankara lost to the opposition for the first time in a quarter of a century.

New Governor

Current central bank Governor Sahap Kavcioglu took office in March following Erdogan’s dismissal of Naci Agbal after just four months in the job. Agbal was a proponent of rate increases to tackle inflation, while Erdogan, bucking economic convention, argued that lower borrowing rates help tame consumer-price gains. Kavcioglu is Turkey’s fourth central bank chief in less than three years.

Going forward, investors will be focused on how much of the positive response by global foreign-exchange markets is maintained when traders in the region have the opportunity to really weigh in. It also came in a holiday-affected week and ahead of year-end, factors that have historically affected market liquidity.

Prior to the recent rebound, the lira had lost about half of its value against the U.S. dollar since September, with declines gaining pace after Erdogan last month unveiled an economic model that relies on lower borrowing costs and a cheaper currency. Erdogan has said Islam demands lower rates.

The central bank has slashed the one-week repo rate by five percentage points since September, in line with Erdogan’s demands. The monetary authority has also intervened in the foreign-exchange market four times this month to stop the currency depreciation.

(Updates with lira’s latest move, adds volatility metrics and chart.)