• USDTRY has popped to the highest since the beginning of the year
  • US and Turkey have mutually suspended their non-immigration visa services
  • Turkish lira’s volatility term structure spikes at the front end of the curve

The Turkish lira has weakened against the US dollar the most since the beginning of this year following a diplomatic spat between Turkey and the United States as both countries have chosen to suspend their non-immigration visa services, the move which could afflict those who are looking to visit the other country. The moves from both sides followed the arrest of a Turkish national who works at the US consulate in Istanbul for alleged involvement in the July 2016 coup attempt against President Recep Erdogan. The statement from the US Embassy based in the Turkish capital suggests that “recent events” were key to implement visa restraints, those events were not been singled out though.

link do file download linkThe statement of the US Embassy in Turkey. Source: Twitter

Even as a knee-jerk reaction on the USDTRY could have been just a straightforward response to an outbreak of a spat, a severe sell-off of the Turkish currency could be fueled by still poor fundamentals as well. Keep in mind that the Turkey’s economy faces a hefty current account deficit which averaged $4.75 billion a month for the last three months. Moreover, the latest inflation report illustrated that the price dynamic stood at a double digit level exceeding 11% in September. Notice the higher inflation is the less real yields the country’s assets could offer (all others equal) which leads to an outflow of capital hurting the currency.

link do file download linkThe Turkish lira’s volatility terms structure steepened at the front end following an outburst of a diplomatic clash. Source: Bloomberg

Political uncertainties have caused a massive increase of short term options volatility which suggests substantial hedging against further depreciation of the Turkish currency. For instance, one-month volatility surged 245bps to stand at 12.77%, the highest since 22 May. What’s more, risk reversals which measure a relative ratio of implied volatility between calls and puts surged markedly as a one-week gauge increased over 100% compared to the close on Friday.

link do file download linkThe USDTRY has registered an incredible move upwards but the pair has handed back some of its gains since then. Source: xStation5

A technical analysis could suggest that the pair could be still under pressure in the nearest term even as the price has given back a part of its gains so far. A critical support area, where more buyers could lurk, is placed in the vicinity of 3.6150. Taking into account that the Turkish bonds offer just a bit higher a real rate of return compared to the US securities, one could assume that larger corrective moves on the USDTRY could be confined. This is especially true when we take account of still poor fundamentals of the Turkish economy and the outlook for higher rates in the US.