The Turkish currency has gained more than 10% since President Erdogan parted ways with the central bank governor. The dollar fell back below 8 pounds to 7.70 pounds and the euro is worth 9.10 pounds on Thursday. Markets are anticipating an interest rate hike on November 19 to limit inflation.

The dismissal of the governor of the Turkish central bank by President Erdogan caused a massive rebound of the Turkish lira in 4 sessions. She has gained 10% since that dismissal.

The dollar reached 7.70 pounds on Thursday. It had fallen 5% from 8.20 to 7.80 pounds on Wednesday. Strategists at the Deutsche Bank estimate the exchange rate of the Turkish currency at between 7.40 and 7.80 pounds per dollar. It is still cheap and undervalued with currencies like the South African Rand, Chilean peso and Brazilian real.

One euro is worth 9.10 pounds. The European currency recorded an annual high of 10.19 pounds last week.

Markets believe that the Turkish president, long reluctant to face this solution, will let the new governor of the central bank raise interest rates to control galloping inflation. An indispensable initiative to restore confidence in the currency.

Rate at 14.25%

Phoenix Kalen, emerging markets strategist at SG, expects the repo rate to rise 400 basis points to a week at the next monetary policy meeting on November 19. It would stand at 14.25%, well above the rates of its counterparts in other emerging markets. For the setting of its interest rates, the country uses a complex corridor system where they fluctuate daily between 10% and 14%. This makes it difficult for markets to see clearly what the central bank's intentions are in the fight against inflation. A simplification may be considered by the central bank. A monetary status quo on 19 November would cause the pound to fall sharply.

Capital controls that are too risky

The strategist does not believe in strict new capital controls. "They are complex to put in place and would risk diverting foreign investment." Foreign investors now hold only $20 billion worth of Turkish shares, up from $80 billion in 2013. The rate of ownership of Turkish assets (stocks and bonds) by non-residents reached 3.3% in September and compared to more than 20% in 2013.

Disastrous results

The former governor of the central bank, Murat Uysal, was punished for his disastrous 18-month balance sheet: loss of a third of its value for the pound, acceleration of inflation, plunge in foreign exchange reserves. These reserves, a financial security mattress, cover only two months of imports compared to six in 2017. The markets no longer had any confidence in Murat Uysal. But its failure is also that of a government that prioritizes growth over price stability and balances (financial, external).

Gradual return to emerging markets

After $7.5 billion in September, foreign investors invested nearly $18 billion in emerging market assets in October. They invested $11.7 billion in bonds, including Asian bonds, and $6.3 billion in equities, including $4.7 billion in Chinese equities, according to data from the Institute for International Finance (IIF). Investors are starting to invest again in Latin America. In the first 10 months of the year, emerging market equities, excluding China, still show net outflows of nearly $70 billion. Emerging market debt attracted nearly $100 billion from abroad and Chinese equities more than $20 billion.

Attracting capital

In the week before the US presidential election, the Turkish lira had been the second most heavily sold emerging currency by hedge funds behind the Polish zloty, according to Citi Bank. Over the last 4 weeks most of the selling pressure on the Turkish currency comes from banks and then hedge funds. Companies took advantage of the decline to buy books. "After Joe Biden's victory, markets are looking for good reasons to reinvest in the emerging sphere. A rise in interest rates in Turkey would again attract capital to the pound," said Robin Brooks, chief economist at the Institute of International Finance. The potential for rebound is still 5% according to him.

Traders will borrow money in currencies that have low interest rates like the euro and yen and then invest in currencies like the pound that have high interest rates. These so-called "carry trade" operations will accentuate its rebound if they materialize sustainably.

$1500 per capita

In two years, Turkey's central bank has mobilized $128 billion, or 16% of its GDP or $1500 per capita, to try to stem the plunge in its currency. Public banks are also mobilized to raise the currency. The fall in the central bank's reserves leads to consider other solutions such as raising interest rates to restore confidence in the currency and avoid social unrest.

Credibility to be restored

Nacy Agbal, the new governor recalled in his first statement that the main objective of the central bank was price stability and that he would use all the tools to achieve it. The situation is "closely monitored" between now and the November 19 monetary policy meeting. An increase in interest rates could be announced. It would curb inflation and restore the credibility of the central bank, which is considered too dependent on political power. Long reluctant to monetary tightening, President Erdogan may have resolved to do so, the markets say. A monetary status quo would be very badly perceived and the currency would experience a new period of turmoil.