The Turkish lira (TRY) began the week on July 30 testing rates weaker than 4.90 against the USD after Fitch Ratings warned in a report that negative outlooks on banks in Turkey reflected the continued prevalence of multiple risks. The credit profiles of the country’s banks, subject to widespread rating downgrades in July, remained exposed, according to the ratings agency.

The TRY was trading at 4.9046, a retreat of 1.29% d/d against the dollar, as of 14:00 local time. By 16:45, it stood at 4.8749. The benchmark BIST-100 Istanbul stock market index was down 0.15% to 95,440 in early afternoon trading while the banking stocks index was down 0.45% d/d.

The row between Ankara and Washington over US pastor Andrew Brunson, facing a trial on terrorism and espionage charges, continued, adding to the negative sentiment in the markets. On July 29, US Vice President Mike Pence reiterated in a tweet and a televised interview that the US was prepared to bring sanctions against Turkey unless Brunson, now under house arrest, was given his liberty.

Another risk factor this week is the US Fed’s monetary policy committee (MPC) meeting scheduled for July 31 and August 1. A rate hike from the Fed could trigger another mass sell-off in emerging markets. Over July 30-31, the Bank of Japan will also hold an MPC meeting while the Bank of England’s MPC will convene on August 2.

On July 31, the Turkish central bank will release its latest inflation report, in which it is expected to significantly hike its end-2018 inflation forecast to establish more logical monetary policy ground.

On August 3, the Turkish statistical institute (TUIK) will announce the July inflation figures. The market consensus is that Turkey’s annual inflation has at least a bit further to rise.

Turkey’s annual consumer price inflation jumped from 12.15% in May to 15.39% in June, taking the rate up to the highest level recorded since 2003, the Turkish Statistical Institute (TUIK) announced on July 3.

Capital Economics expects a further increase in CPI inflation to 16.7% y/y in July.

Trade war concerns or geopolitical tensions over Iran could also escalate at any time to create market fluctuations.

A much bigger and perpetual concern for Turkish assets is that economic populist President Recep Tayyip Erdogan could at any time make more comments calling for an unorthodox loosening of monetary policy. Traders would very likely respond by dumping more lira.

As things stand, some famous bear traders have started to make louder pronouncements on why certain Turkish assets should be shorted.

The severe depreciation of the TRY—it has lost more than 20% of its value in the year to date—as well as higher interest rates and slowing economic growth pose significant risks to Turkish banks’ performance, asset quality, capitalisation, funding and liquidity metrics while Fitch expects the Turkish banking sector performance to deteriorate across 2018. Most of the ratings of Turkey’s banks are still on Negative Outlook or Rating Watch Negative.

Asset quality is at risk from exchange- and interest-rate pressures (particularly at banks with large or concentrated foreign-currency loan portfolios), high Stage 2 (watch list) loans (which have generally increased under IFRS 9), high restructured loans, single-name risks and exposure to risky sectors, for example, construction, energy and project finance, the rating agency also said on July 30.

Capital ratios are sensitive to lira depreciation, which inflates foreign-currency risk-weighted assets. Fitch estimates that a 10% lira depreciation against a basket comprising 70% US dollars and 30% euros would have reduced the sector's end-May capital adequacy ratio by 40bp to 15.6%. Higher interest rates, which reduce bond portfolio values, and weaker asset quality also pose risks to capital ratios.

Foreign-currency wholesale funding accounts for a high proportion of the Turkish banking industry's total funding (28% at end-May 2018) and most of this is short-term. Turkish banks' funding is therefore significantly exposed to investor sentiment and Turkish country risks. Funding costs have risen and demand for some instruments has fallen, although market access has generally remained reasonable. Most banks have sufficient foreign-currency liquid assets to cover foreign-currency wholesale funding liabilities due within a year, but prolonged market closure could put pressure on liquidity, the ratings agency also said.