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Turkey's Surprise Rate Hike Boosts ETF, Will the Rally Last?

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Turkey’s central bank raised interest rates for the first time since a currency crisis in late 2018, surprising the world in a low-rate environment. Turkey’s central bank increased interest rates by two percentage points, pulling the beleaguered lira off record lows. The sole country ETF iShares MSCI Turkey ETF (TUR - Free Report) gained about 3.8% on Sep 24.

Foreign exchange traders have punished the lira this year as Turkey has exhausted foreign exchange reserves during the coronavirus pandemic. Soaring demand for safe-haven or hard currencies probably has also resulted in lira’s weakness. To save the liar’s value, Turkey has resorted to this move.

The lira’s latest crash is even more appalling given the fact that the U.S. dollar was also on a downtrend. Invesco DB US Dollar Index Bullish Fund (UUP - Free Report) lost 2.6% in the past three months. Even against this backdrop, Turkish lira lost about 10.6% against the U.S. dollar in the past three months. Prior to the central bank rate hike announcement, the lira was trading at its latest all-time low of 7.7207 against the dollar. The lira has shed about 20% of its value this year.

Inside the Rate Hike

Turkey’s central bank stunned the global markets on Sep 24 by hiking its main policy rate (one-week repo) by 200 bps to 10.25% in an unexpected move. The step boosted the overnight lending rate and late liquidity lending rate within the national lender’s “corridor policy” by 200 bps to 11.75% and 13.25%, respectively.

Per policymakers, the rate hike decision looks to restore the disinflation process and support price stability as the lira has hit an all-time low. The central bank also said that economic activity is improving considerably in the third quarter due to easing lockdown measures and “the strong credit impulse, while inflation rate has been higher than expected.”

Notably, Turkey's consumer price inflation rate was 11.77% year over year in August 2020, slightly changed from the previous month's 11.76% and compared with market expectations of 11.91%. Post the central bank's move and lira’s restoration in value, Turkey’s pure-play fund TUR has gained considerably.

Turkey ETF in Focus

The fund seeks to deliver investment results that replicate the price and yield performance of the MSCI Turkey IMI 25/50 Index which is composed of Turkish equities. Consumer Staples (23.46%), Financials (22.99%), Industrials (18.66%) and Materials (14.48%) are the top sectors in the fund. With AUM of $189.3 million, the fund has 41 holdings. It has an expense ratio of 0.59%.

Will the Rally Last?

While the rate hike propelled Turkish stocks higher, the way ahead from here may not be smooth. This is especially true given that the coronavirus infections are spreading in Europe.

Turkey’s monetary policy is majorly governed by the country’s president. Notably, the Turkish president fired “the bank’s previous governor in July last year, complaining that he “wouldn't follow instructions” on interest rates,” as quoted on Financial Times.

President Erdogan is a proponent of low rates. The central bank has enacted a series of rate cuts in the past one year after the appointment of a new governor.

Erdogan sought to reach single-digit rates in order to get back the country’s faster credit-induced growth that we had seen before, as indicated by the Financial Times article. Against this backdrop, how much further rate hike is possible in the coming days is doubtful. This keeps endangering the lira’s future too.

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