Downed Fighter Jet Could Be Bad News for USD-TRY

Downed Fighter Jet Could Be Bad News for USD TRYDowned Fighter Jet Could Be Bad News for USD-TRY

After the optimism at the start of November, as the AKP Party won a decisive and stabilizing majority in the Turkish parliamentary elections, the Turkish lira (TRY) is heading for a sudden turnaround—for the worse.

For investors, however, the USD-TRY pairing still offers potential for high returns, so long as they switch their bullish TRY positions to bearish, as currency markets react to news that a Russian “Sukhoi Su-24” fighter plane targeting Islamic State positions was shot down by a Turkish “F-16” at the Turkish-Syrian border.

European stock markets were also under pressure, as geopolitics has resurfaced as a significant market influencer after Turkey’s downing of a Russian jet. The FTSE MIB dropped 1.3%, on trend with other European exchanges. Airlines and any companies related to travel and luxury were among the major losers. The euro remains weak, just above $1.06, moving ever closer to parity with the dollar.

The Kremlin has described the incident as “very serious.” (Source: “Kremlin calls Russian warplane downing in Syria ‘very serious incident,” Hurriyet Daily News, November 24, 2015.) No doubt, Russia’s president, Vladimir Putin, will find some way, economic or political, to retaliate against Turkey, which puts the Turkish currency (TRY) at risk, favoring the dollar in the USD-TRY relationship. In the forex markets, the U.S. dollar rose to 2.8861 relative to the Turkish lira, or 0.54% higher. Just before 8:00 a.m., however, the Turkish currency was the one gaining strength against the greenback.

If a 0.54% shift in the USD-TRY currency pairing does not concern those holding long positions on the Turkish currency, the long-term effects on the TRY could be significant. Russia will retaliate in strategic ways, mostly aimed at weakening President Erdogan’s interests, meaning Russia will seek to penalize Turkish economic activity and trade. Russia will surely try to consolidate its influence in the Turkic republics of Central Asia, such as Kirgizstan, Turkmenistan, Azerbaijan, and Uzbekistan, where Ankara and Moscow have been competing for years.

Meanwhile, the USD-TRY relationship was already moving in favor of the dollar last week, regaining lost ground and returning to pre-Turkish election levels, above 2.93 Turkish lira. What prompted that high pricing? The U.S. economy is in good—if not great—shape, which has raised expectations of the Federal Reserve raising interest rates, however marginally, in December.

Moreover, last week, several market movers weighed on the USD-TRY forex and the macroeconomic data have supported the strength of the U.S. dollar. The Purchasing Managers’ Index (PMI), which gives a good indication of manufacturing strength, showed that the U.S. dollar remains very strong, perhaps too strong, given that it has hurt manufacturing exports. (Source: “Markit manufacturing PMI slides to 2-year low,” Business Insider, November 23, 2015.)

Why Is Turkey Relevant Anyway?

Not only has the USD-TRY met resistance at 2.9346, but it has also fallen back in line with the downward trend that was characteristic of last summer, following the shallow majority government that resulted from the June election in Turkey. Now, the USD-TRY has fallen on a downward slope that could see it drop even lower than last summer, because the risks are much more significant. Indeed, the order to shoot down a Russian plane, which crashed on the Syrian side of the Syro-Turkish border, is nothing short of an attempt by the Turkish leadership to drag NATO and the United States deeper into the Syrian conflict.

The war in Syria has just exceeded what many analysts considered the critical threshold: for the first time, two of the foreign powers involved in the conflict, Turkey and Russia, have clashed directly. The incident was predictable. Ever since Russian air force jets have started to target rebel and Islamic State positions in Syria, Turkey has denounced airspace violations and, on occasion, sent its fighters to intercept Russian jets.

In recent days, tensions rose as the Russian-protected Syrian army advanced toward villages occupied by Turkmen rebels, loyal to Ankara and fighting Syria. Turkey had threatened “serious consequences” if the Russian air force did not immediately stop supporting the Syrian offensive. Russia has ignored the warning, probably thinking that this time, Ankara was bluffing. It was wrong.

Turkey wants to prevent the northern region of Aleppo, given the support from the Russian air force from falling in the hands of the Syrian army. Ankara is stepping up the pressure to get the support of the West to the creation of a so-called “safe” zone, an area where the Syrian army and its allies would be banned from entry.

However, Islamic State militants hiding from the Syrian army and from Russian attacks could easily use these safe zones. Turkey has shown repeatedly, as the attack against the Russian jet makes all too clear, that it cares very little about ISIS and much more about the rising Kurdish tide. Perhaps Turkey will care about the missile cruiser deployed in the Mediterranean, threatening to attack any hostile forces. (Source: “Russia deploys missile cruiser off Syria coast, ordered to destroy any target posing danger,” RT News, November 24, 2015.)

Turkey’s Action Could Backfire

Indeed, Turkey wants to stop the advance of YPG Kurdish militias, while keeping links open with the Islamist Syrian rebel groups backed by Ankara. Russia is totally against this plan. Turkey, after the solid AKP Party victory, does not intend to give up the goal of overthrowing Assad. As the West starts to consider the notion of the Russian plan to stabilize Syria, keeping Assad in power and prompting elections, fearing France’s opening toward Moscow, President Hollande is to visit Putin. Turkey’s president has found a way to escalate the conflict.

Now, the West will have to choose whether to side with Putin’s Russia or with Ankara as part of NATO obligations. Nevertheless, the West has no appetite to get more involved in Syria, especially since it is likely that Russia will retaliate in response to the downed jet by deploying ground troops or intensifying its campaign. Moreover, if the West does not ease sanctions against Russia in the wake of intensifying tensions in Ukraine, Putin will see that he has nothing to lose in going full-out to assert Russian influence in Syria, which has been a strategic asset for Moscow for decades.

Meanwhile, Erdogan and the AKP’s focus on weakening Kurdish interests will inevitably weaken Turkey’s economy, draining resources and subjecting the country to risks of a renewed internal struggle, which has cost several thousands of lives over the years. Presumably, the Turkish government fears that as the areas in Syria, now controlled by Turkmen and the Islamic State (ISIS), fall to Kurdish fighters targeting ISIS, eventually giving birth to an autonomous Kurdish entity.

President Erdogan and Prime Minister Davutoglu, rather, would prefer to hold the areas separate, establishing the protective umbrella of a no-fly zone, thereby preventing the formation of an autonomous Kurdish entity. However, this plan has never received the endorsement of the NATO allies. By targeting Russia, Erdogan has dragged NATO into his designs. Whether NATO responds favorably in the wake of the Paris attacks on November 13 and a growing fear of ISIS terrorism in Europe is another matter; indeed, Erdogan may have overplayed his hand. In economic terms, the U.S. dollar will soar compared to the Turkish lira in the next few weeks.

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