Turkey: Why shouldn't the weak industrial activity lead to a rate cut?

Forex News and Events:

Turkish industrial production unexpectedly contracted by 1.0% m/m in May, pulling the yearly production pace down to 3.3%. From a macro-fundamental point of view, the news has nothing exciting, however the implications on the monetary platform keeps TRY-appetite intact. Post production data, USD/TRY extends losses to 2.1213 (at the time of writing); the average repo rate hit 8.01% in Istanbul yesterday for the first time since January 28th (the day before CBT emergency rate hike amid lira hit 2.39 vs USD).

The rationale behind the “stronger” TRY story is crowded. Some think that the slowdown in industrial production should weather the domestic demand, thus the inflation dynamics over the next months. Lower inflation should pave the way for lower rates to revive the weak industrial activity and to boost growth. Higher growth perspective should, at its turn, attract international capital flows and thus, is TRY-positive.

We believe that the real reason behind the TRY strength is as simple as the international carry flows still favoring the high yielding EM – thus TRY and TRY holdings. In addition, from a pure economic point of view, the weak industrial production has more chance to sustain the consumer price inflation unless domestic demand drops sharply. This is the trivial law of offer-demand, to which we add the inevitable geopolitical dimension. The ongoing tensions in Iraq and the consequent higher and steeper energy curve are no good news for Turkish growth perspective, nor for its inflation levels. Finally, the political uncertainties before Turkish presidential elections (due in August) rise the negative volatility risk in TRY, therefore reaching a disinflationary frame in months ahead becomes more challenging. The above-stated factors strongly require a hawkish stand from the Central Bank of Turkey in July 17th meeting.

One thing is sure: the future of Turkish consumer price dynamics is still a big unknown. Given the macroeconomic / geopolitical ambiguities, a commitment for lower rates is an irresponsible monetary strategy. We understand that the international capital flows are in favor of high yielding EM currencies at the moment – and may generate opportunities for short-run tactical deviations – however, the rationale of “lower rates for higher growth” is meaningless when the price stability is not secured. In this respect, the Central Bank of Turkey predicted the beginning of inflation cool down from June. In June report however, the CPI y/y retreated slightly to 9.16%, instead of 8.80% anticipated by economists (& still lower than Swissquote’s official forecast 9.50%). What a disappointment for cheap-money-based-growth hunters!

Now that we explained why traders should not adhere easily to lower inflation / higher growth scenario, our reluctance vis-à-vis inflation dynamics is perfectly in line with short-term rise in TRY (expectations for more hawkish policy action in July 17th MPC meeting) and mid-long run sustainable TRY-liquidation (as moderate cuts distort risk-to-return ratio and should discredit the lira in term).

The Central Bank of Turkey should think twice before proceeding with further “moderate” rate cuts. Growth is a mid-long term goal; the fragile capital flow dynamics cannot build a healthy base to take advantage of carry friendly environment. Given the heavy pressures from the ruling AKP government, we expect an additional 50 basis point cut on weekly repo rate by next week, the overnight corridor should be kept steady at 8.00-12.00% especially on the upper end. These “moderate” rate cuts carry important mid/long term stability risk. The failure to reverse down the inflation dynamics will result in need for longer period of higher rates to temper both lira weakness and the overheating inflation in the foreseeable future.

Today's Key Issues (time in GMT):

2014-07-09T11:00:00 USD Jul 4th MBA Mortgage Applications, last -0.20%
2014-07-09T12:15:00 CAD Jun Housing Starts, exp 190.0K, last 198.3K
2014-07-09T18:00:00 USD Fed Releases Minutes from June 17-18 FOMC Meeting

The Risk Today:

EURUSD EUR/USD is bouncing. The hourly resistance at 1.3621 has been breached. However, we continue to favour an eventual decline towards the support at 1.3503 as long as prices remain below the resistance at 1.3664 (03/07/2014 high). An hourly support can now be found at 1.3576. In the longer term, the break of the long-term rising wedge (see also the support at 1.3673) indicates a clear deterioration of the technical structure. A long-term downside risk at 1.3379 (implied by the double-top formation) is favoured as long as prices remain below the resistance at 1.3775. Key supports can be found at 1.3477 (03/02/2014 low) and 1.3296 (07/11/2013 low).

GBPUSD GBP/USD has breached the hourly support at 1.7096 (01/07/2014 low) suggesting a weakening buying interest. Hourly supports lie at 1.7086 and 1.7007 (27/06/2014 low). Hourly resistances can now be found at 1.7148 (08/07/2014 high) and 1.7180 (04/07/2014 high). In the longer term, the break of the major resistance at 1.7043 (05/08/2009 high) calls for further strength. Resistances can be found at 1.7332 (see the 50% retracement of the 2008 decline) and 1.7447 (11/09/2008 low). A support lies at 1.6923 (18/06/2014 low).

USDJPY USD/JPY has weakened near the resistance at 102.36 (18/06/2014 high). Prices are now approaching the support at 101.24. An hourly resistance lies at 101.86 (intraday high). A long-term bullish bias is favoured as long as the key support 99.57 (19/11/2013 low) holds. However, a break to the upside out of the current consolidation phase between 100.76 (04/02/2014 low) and 103.02 is needed to resume the underlying bullish trend. A major resistance stands at 110.66 (15/08/2008 high).

USDCHF USD/CHF is fading near the resistance implied by its declining channel. The hourly supports at 0.8918 (intraday low) has been broken. Another support can be found at 0.8886 (intraday low). Resistances stand at 0.8959 (07/07/2014 high) and 0.8975. From a longer term perspective, the bullish breakout of the key resistance at 0.8953 suggests the end of the large corrective phase that started in July 2012. The long-term upside potential implied by the double-bottom formation is 0.9207. A key resistance stands at 0.9156 (21/01/2014 high).

Resistance and Support: