The USD/TRY exchange rate has continued its strong rally this year as the Turkish lira plunged to its lowest level on record. It was trading at 36.32 on Thursday, up from the year-to-date low of 35.14. It has jumped by about 500% in the last five years, making the Turkish lira one of the worst-performing currencies globally.
CBRT and Federal Reserve divergence
The Turkish lira has crashed because of the ongoing monetary policy changes by the Central Bank of the Republic of Turkey (CBRT) and the divergence with the Federal Reserve in the United States.
The CBRT has embarked on a rate cutting cycle in the past few months after data revealed that inflation was falling.
Economic data released this year showed that Turkey’s inflation continued falling. The headline consumer price index (CPI) dropped to 42.12% in January from 44.3% in the previous month. It has been in a steady downward trend after peaking at 75% in June last year.
The CBRT has slashed interest rates from 50% last year to 45% today, and analysts believe that it will deliver more cuts later this year.
Officials have defended the move noting that interest rates remain restrictive. Besides, the country has one of the highest interest rates this year.
The CBRT is cutting interest ears for two main reasons. First, President Erdogan hates high interest rates and officials are working to fulfil his ambition. Second, it hopes that the rate cuts will help to supercharge the economic growth.
The most recent data showed that the Turkish economic growth has largely stalled. It expanded by 2.1% in the third quarter of last year, the slowest rate since the Covid-19 pandemic. Businesses and consumers blamed high interest rates for affecting the economic growth.
The economic growth slowed also because of a small increase in value added taxes (VAT) and fuel prices. Recent flash economic numbers showed that the sector continued to slowdown in January. The manufacturing PMI slowed to 48 from the previous 49.1.
The USD/TRY has also surged as investors anticipate trade issues with the United States. A key issue is that the US still has a trade deficit with Turkey. Also, Turkey has weak relations with Israel, which may push for sanctions by the Trump administration.
Hawkish Federal Reserve
The USD/TRY exchange rate has surged this year because of the hawkish Federal Reserve. Minutes released on Wednesday showed that most Fed officials pointed to high inflation numbers in the last meeting.
Officials believe that interest rates should remain higher for longer as inflation risks remain. The most recent data showed that the headline Consumer Price Index (CPI) rose from 2.7% in December to 3.0% in January. Core inflation remained above 3% during the month.
Therefore, a hawkish Fed and a dovish CBRT means that the spread between US and Turkish rates will remain low. That, will, in turn reduce the carry trade benefit of the two currencies.
A carry trade is a situation where investors borrow from a low interest country to a high rate one. As such, the carry trade opportunity narrows as interest rates converge. Still, the USD/TRY pair is still one of the most popular carry trade opportunities.
USD/TRY technical analysis
USDTRY chart by Tradingview
The daily chart shows that the USD to TRY exchange rate has been in a strong bullish trend in the past few years. It has jumped from about 6.20 in 2020 to 36.20. The pair has moved above all moving averages, while oscillators are pointing upwards.
Therefore, the USD/TRY pair will likely continue rising as bulls target the next key resistance level at 40.
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