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The Turkish lira may be set for even more pain despite attempts by the country's banking regulator to curb investors' ability to buy and short the national currency.
Quick political fixes tend to provide short-term rallies to foreign exchange markets, but frequently lead to a resurgence in volatility in a matter of days, according to Macquarie Research.
"Judging by the standards of past FX-economic-political crises, Turkey's three-week old volatility has hardly begun," wrote Thierry Wizman, global interest rates and currencies strategist at Macquarie Group. "An interim rally in a currency that is in crisis (like the one we see today in the TRY) is not unusual."
Turkey's Banking Regulation and Supervision Agency on Wednesday reduced the amount of swap market contacts that offshore banks can undertake in the hopes that reducing access to the besieged currency can provide temporary stability. The agency has stipulated that banks can no longer run swap contracts above 25 percent of the equity that they hold. The figure was previously 50 percent.
The lira fell as much as 20 percent against the U.S. dollar on Friday and another 6.6 percent Monday to end the session at 6.88, reaching new record lows throughout the past week.
The Turkey currency pared those losses Wednesday, rising 3.8 percent. (On the chart above, an increase equals a weakening Turkish lira.)
The strategist highlighted past crises, such as the 1997 Asian currency turbulence, when the International Monetary Fund intervened to help stabilize the Thai baht, the South Korean won and others. But while the IMF's help initially helped spur brief rallies, those turnarounds usually lasted "merely a few days" and results in persistent aggravation for both short sellers and buyers alike.
Source: Macquarie Research, Bloomberg.
"The rallies in FX triggered by IMF intervention were not the start of sustained FX rallies. (Indeed, Indonesia got four IMF programs, anyway, before stabilizing.) The economic adjustments, defaults, and IMF conditionality triggered by the devals led to political volatility," Wizman added. The political volatility in turn "created more uncertainty and endured for many months. In any case, trading remained treacherous well into mid-1998."
Source: Macquarie Research, Bloomberg.
"In any case, the Turkish lira may move up or down in the short term, but the broader point is that surprise and its bedfellow – volatility — will remain around the corner for another year in the lira," he said.
To be sure, continued volatility in emerging market currencies doesn't necessarily spell downside for U.S. equity markets.
Nicholas Colas, DataTrek Research co-founder and former chief market strategist at Convergex Group, said in a note Wednesday that such crises take time to develop and that U.S. stocks may still have room to run before currency woes start to have sustained impact.
"Summing up, there are three points to keep in mind: Emerging market crises take time to develop, and at first U.S. stocks will ignore any potential impact," he wrote. "U.S. equities can continue to rally even as a crisis takes hold, provided there is no adverse impact to the U.S. economy.
"Emerging market-crises do make the chance of wild – but short – swings in equity prices more likely," he added. "Forewarned is forearmed on this point."