aaven replies to: Training Journal

28/06/2018

My attention has been brought to the possible undervaluation of the Turkish Lira. Due to political instability with their president. the Lira sold off heavily in recent times.
That selling seemed to be curtailed by the aggressive interest rate hike by their central bank. Below is my thesis.

This is the annual GDP growth rate of Turkey over the past 5 years. The trend seems to suggests an accelerating GDP growth for Turkey. Which started around mid 2016. Although it can be argued that this level of GDP growth is roughly “normal” for Turkey, based on past performance.

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Next, we look at the unemployment rate. It is apparent that Turkey experienced an increasing trend in their unemployment rate. This trend peaked around end 2016 and had come down to sub 11 percent mark. This suggests to me that something is happening in the economy to dampen the increasing trend in unemployment. Which could be inferred as good for Turkey.

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The next two charts are for Turkey’s inflation and core inflation rate. Both are considered high by recent standards. And thats the main reason for Lira’s massive devaluation. Logically, central banks will want to pursue a tighter monetary policy (read: raise interest rate). In Turkey, they have the usual interest rate, liquidity window rate, overnight lending rate and overnight borrowing rate. Quite confusing to traders not familiar with the matter. Just know they all function very similar to interest rates.

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Now onto the political side. In short, Turkey’s president (Erdogan) have a unique perspective on controlling inflation. He believes that inflation can be controlled by LOWERING interest rate. This is contrary to what mainstream economics and the markets think. Why is that a problem? Well it seems that he is consolodating his power and might exert pressure on Turkey’s central bank to lower interest rates. Which the market perceive as a a risk to the economy. This combined with the runaway inflation that Turkey is facing led to many investors wanting out of Turkey. The good news is that the central bank raised interest rates far more aggressively to combat inflation. Also signalling their independence. This seems to have stopped the devaluation of the Lira for now.
Also, recent US dollar strength and rising interest rate created a double whammy. As much of the funding currency was denominated in USD. Carry strategies and investments into emerging markets have started to unwind. Causing a widespread devaluation in emerging markets.

Now that Erdogan has won the recent election. What remains to be seen is how he shall go about dealing with the vast problems that Turkey faces. Especially of interest is economic issues. Based on the data, I seem to hold the view that Turkey’s economy is not that bad. They are growing steadily. The high inflation might spur more rate hikes from their central bank. In my opinion, investors seem to be put off mainly by the political uncertainty. And if resolved, may make Turkey an attractive market to invest in. I will be adding the Turkish Lira to my watchlist and monitoring the situation for now. If Erdogan does indeed have a positive change in his views, I may take a long TRY position. Potential candidates for counter currency are Euro, Canadian Dollar and British Pound.

I look for value wherever it can be found

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