The Turkish lira (TRY) was off to a stomach-churning start on August 27 following Turkey’s week-long public holiday, losing more than 3% against the dollar as investors continued to fret that the country’s currency crisis could morph into something much worse.

With Ankara’s diplomatic rift with Washington over detained US pastor Andrew Brunson not resolved, and the Turkish government continuing to blame an “economic war” unleashed by foreign powers for Turkey’s woes rather than economic fundamentals, the TRY slid as far as 6.2815 to the USD by just past noon, local time. It trimmed losses to 6.2228, down 3.63% d/d, by 15:00. The currency hit an all-time low of 7.24 earlier this month.

“The exchange rate sensitivity created by the tension between us and the United States continues,” Seda Yalcinkaya Ozer, an analyst at brokerage Integral, told Reuters, adding that emerging market currencies were generally weaker against the dollar.

Option markets showed investors bracing for more TRY trouble as Turkey prepared to get back to work following the holiday.

With markets concerned the currency crisis could lead to a debt and solvency crunch, the cost of short-term insurance against swings in the severely devalued currency—down towards 40% against the dollar in the year to date—remained the highest for any currency in the world, even after retreating from a recent peak, Bloomberg data showed on August 26. One-week dollar-lira implied volatility was about 44% on August 24, down from as high as 86% on August 13. The so-called volatility curve is downward sloping up to the one-year tenor, which is at about 28%.

During the holiday, TRY trading was relatively calm with local markets shut but strategists are warning more turbulence is ahead unless the nation’s policy makers adopt a more market-friendly approach. Ankara has not signalled that any major interest rate hike—which is desired by the market consensus—is ahead and the government says it does not have capital controls or an approach to the IMF on the agenda. However, a major fiscal tightening is ahead, according to finance ministry plans.

"Relief will be short-lived"
“Relief will be short-lived and more action is needed,” Guillaume Tresca, a strategist at Credit Agricole in Paris, was quoted as saying by the news agency. “Turkish officials have to create a credibility shock.”

Turkey’s inflation, recorded as at a 15-year high of 15.85% in July, is expected by most analysts to gain a few more points in coming months.

The August inflation data will be released on September 3.

The Turkish central bank’s rate-setters will meet on September 13.

Turkey has raised rates by 500bp since April, but it needs to boost them by another 600bp to stabilise markets, according to Societe Generale.

“Ideally, a more substantial external financing support that comes on the condition of undertaking correct macro policies—such as an International Monetary Fund programne—may be required to turn the fortunes of the currency,” Kiran Kowshik, a strategist at UniCredit, was cited as saying by Bloomberg. “However, this appears to be a long way off. Expect the lira to remain under pressure in wide choppy ranges.”