(Bloomberg) -- The risk of U.S. sanctions over Turkey’s purchase of a Russian defense system has clouded the lira’s outlook for most of the year, but it still managed to give the currency a jolt when the threat was reiterated.
The lira sank as much as 1.5% against the dollar before trimming its decline, after people familiar with the matter said the Trump administration is weighing three sanctions packages to punish Turkey. One of the packages would all but cripple the nation’s economy, the people said, and that’s probably behind the knee-jerk reaction today.
Concern over the implications of the Russian S-400 missile-defense deal has weighed on the lira for months and contributed to its 10% loss this year, the biggest depreciation in emerging markets after Argentina’s peso.
According to the people familiar with discussions in Washington, the U.S. could impose sanctions on Turkey as early as July, but President Donald Trump is reluctant to make any decision before a Group of 20 meeting in Japan next week, where he’s expected to meet with President Recep Tayyip Erdogan.
“Maybe foreign investors on the sidelines are not willing to make big calls when the story is now very binary,” said Timothy Ash, a strategist at BlueBay Asset Management in London who also cited the “supportive” backdrop for credit and emerging markets this week for containing the currency’s decline.
For others, the risk of sanctions may have already been largely priced in. While the premium option traders pay to sell the lira using one-month risk reversals has sunk from a high in March, the contracts are still up about 60% since the start of the year.
They were trading at 5 percentage points on Wednesday, more than double those for the South African rand.
The lira was 0.5% weaker as of 12:38 p.m. in Istanbul at 5.8591 per dollar, pushing the dollar-lira cross toward its 50-day moving average. The nation’s main stock index was headed for its first loss in four days, while the yield on 10-year government bonds jumped 38 basis points to 18%.
The lira’s decline is “not a huge movement in the bigger scheme of things,” Mingze Wu, a foreign-exchange trader at INTL FCStone in Singapore. “Ultimately Trump threatens a lot of things but delivers very little,” he said, citing threats made against Mexico and Canada.
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