Long TRY-JPY on perpetuation of EM carry thesis – SocGen

Analysts at Societe Generale, expects TRY-JPY to perform well, as they suggest that perpetuation of current market conditions are going to be highly beneficial for this risk-positive position.

Key Quotes

“Favourable investor sentiment has returned to emerging markets, in the wake of Federal Reserve Chair Yellen’s sanguine testimony before Congress last week, in which she envisioned gradual interest rate hikes over the next several years. Evidenced from Friday’s US data releases, disinflationary forces in the US continue to persist, challenging assertions from the Fed regarding the transitory nature of those forces. In the aftermath of these developments, US 10-year Treasury yields have settled down to calmer levels of around 2.30%, while stable Chinese 2Q17 GDP growth data reinforced a benign backdrop for emerging market assets.” 

“In Turkey, economic data continues to be robust (1Q17 GDP exceeded market expectations at 5.0% YoY; manufacturing PMIs have been strengthening this year; capacity utilization has been improving; economic confidence has recently improved, in line with recovery in the currency), even though external vulnerabilities are elevated. Domestic headline and core inflation continue to decline, helped by softening food and transportation prices, in turn bolstering real yield levels and fuelling inflows into the domestic government bond market.”

“The Central Bank of the Republic of Turkey (CBRT) has maintained a commendably tight liquidity policy (with the effective funding rate at nearly 12%), and is likely to continue this stance over the coming months to promote financial stability. The CBRT’s current liquidity policy and use of FX swap facilities will help lend stability to the currency. Although Turkish politics remains a sensitive area, stasis regarding regional political involvement (e.g. in Syria, in Qatar stand-off) can shore up investor sentiment.”

“We believe that USD-JPY may remain range-bound, in line with US Treasury yields, with a potential for USD-JPY to drift gradually higher over the coming quarters alongside a measured rise in US rates. We forecast gradual JPY weakening toward 120 in USD-JPY by year-end. Hence, TRY-JPY may perform well, with perpetuation of current market conditions highly beneficial for this risk-positive position.”

“Expression: Long TRY-JPY spot

We recommend a long position in TRY-JPY, which is currently trading at 31.6940. We target a 7.5% move higher to 34.0711, and place a 3% stop loss at 30.7432. Our trade horizon is 3-6 months. The trade generates positive carry of about +100bp per month.”

“Risks: EM risk aversion, rise in Turkish political risk

An increase in domestic or geopolitical risk, such as escalation in the Qatar diplomatic crisis, could result in marked TRY weakening, impairing the trade. At a macro level, deterioration in risk sentiment (e.g. from resurgence in reflation fears, hawkish Fed / ECB, worries regarding stability of global growth) can also undermine the position. Surprise shifts in monetary policy from the Bank of Japan that result in aggressive investor JPY buying would also be detrimental to the trade.”