Hopes have risen for a breakthrough in ending frosty US-Turkish relations on news of the transfer of jailed US pastor Andrew Brunson to house arrest and there was some, albeit markedly limited, improvement in the standing of the embattled Turkish lira (TRY) during July 26 as investors traded on improved sentiment.

The TRY tested 4.7723 against the USD during early trading hours but by around 17:50 Istanbul time it had slipped back to 4.8582, having stood at 4.8362 at 18:00 on July 25.

Eating away at investors who are dumping the lira is the worry that President Recep Tayyip Erdogan, who continues to favour interest rate cuts despite all the evidence according to orthodox market theory that Turkey's overheating economy needs monetary tightening, could push the country into an emerging market currency-and-debt crisis having seemingly taken away the central bank's independence.

The beleaguered currency has lost more than 20% of its value against the US dollar this year with analysts sensing that the central bank has fallen way behind the monetary curve.

"As far as the lira is concerned—well, as the old saying goes, don't catch a falling knife," Neil Mellor, senior currency strategist at BNY Mellon, told CNBC on July 25. Asked if there was any near-term scope for recovery, Mellor wasn't optimistic. "It's difficult to see a silver lining at present because the recent rise inflation has been fairly dramatic, and some signs of stabilisation will be necessary before the market can heave a sigh of relief."

US Secretary of State Mike Pompeo stepped forward to welcome the news of the transfer of Brunson to house arrest, but pushed for his case to be dealt with as fast as possible. “We welcome long overdue news that Pastor Brunson has been moved from prison to house arrest in Turkey, but it is not enough. We have seen no credible evidence against Mr. Brunson, and call on Turkish authorities to resolve his case immediately in a transparent and fair manner,” he tweeted. 

Turkish markets have for a long time been desperately scanning the horizon for any good news. Market sentiment has also improved somewhat given July 25's news that the EU and US, have, at least for now, averted a trade war by agreeing to substantive talks on pressing matters such as tariffs, but fundamental concerns such as booming double-digit inflation and banking sector vulnerabilities to the real sector’s huge FX debts remain stubbornly entrenched. On July 26, the ECB’s policy rate decision and President Mario Draghi’s comments on the future of monetary policies were also closely watched. The ECB, as expected, left rates on hold and reaffirmed that quantitative easing in the Eurozone would conclude at the end of this year.

The benchmark Istanbul stock exchange BIST-100 index gained 3.51% to 95,368 on July 25 and added a further 1.10% d/d further to 96,421 as of 13:00 local time on July 26. Turkish lira was trading at 4.8251, up 1.09%.

Shares in state-owned Halkbank led the gains on the BIST-100 on July 25 with a day on day increase of 16.37% to as high as TRY7.39 on the Brunson news while they closed the day at TRY7.12. Halkbank shares were also up 0.98% d/d to TRY7.19 as of 12:30 local time on July 26.

However, year on year, Halkbank shares were down 51% on July 25 despite the good day, given fears over the bank's exposure to US regulatory action because of its involvement in the the Iran sanctions-busting.

US prosecutors said on June 26 they planned to appeal against the length of prison term given to Mehmet Hakan Atilla, the international banking head of Halkbank, who was convicted of aiding an Iranian plot to evade sanctions and launder $1bn in oil revenue through the US financial system. The case has been undermining confidence in the whole Turkish banking sector.

The BIST banking index is down 31% y/y although it gained 6.41% d/d on July 25.

Turkish Airlines shares rose by 14.40% to as high as TRY18.19 after the Brunson announcement, while they were down 0.64% d/d to TRY17.01 as of 13:00 local time on July 26 after closing the day at TRY17.12 on July 25.

Annual gains on Turkish Airlines shares stood at 96% thanks to the company’s FX-denominated revenues.

Late on July 25, private lender Akbank said in a bourse filing that its Q2 net income rose by 2.2% y/y to TRY1.6bn. Akbank’s net interest income increased by 42% y/y to TRY3.64bn in the quarter while net fees and commissions income rose by 22% y/y to TRY852mn. However, rising provisions due to an increasing NPL ratio to 2.7% at end-June from 2.3% at end-2017 suppressed the strong rises in the lender’s revenues.

Akbank has a $1.75bn exposure to Ojer Telekom’s (Otas) $4.75bn defaulted loan, the largest default in Turkey’s history.

Otas is the major shareholder of Turk Telekom and it borrowed $4.75bn in 2013 to refinance its acquisition of a 55% stake in Turk Telekom. Garanti Bankasi contributed with $1bn and Is Bankasi $500mn.

Turkish telecom operators are currently hit by rising FX rates since their incomes are in lira and, in most cases, they have FX debts.

Turk Telekom said on late July 24 in a bourse filing that it posted a net loss of TRY889mn in the second quarter versus a net profit of TRY890mn a year ago. Turk Telekom has $2.87bn and €1.1bn worth of FX debts.

Turkcell also said on late July 25 in a bourse filing that its net income declined by 41% y/y to TRY415mn in Q2 due to rising financing costs.

Akbank has an unknown level of exposure to Dogus Holding’s €2bn worth of debt. “There is a disagreement over the maturity. Akbank does not agree with the loan maturity offered by Yapi Kredi and Isbank,” an unnamed source told Reuters on July 9, adding the maturity could be between four and six years.

Akbank shares were up 2.13% d/d to TRY7.19 as of 13:00 local time on July 26 while their annual loss stood at 28%.

Fitch Ratings downgraded Akbank’s Long-Term Foreign Currency Issuer Default Ratings (LTFC IDRs) to ‘BB+’ from ‘BB-’ on July 20 when the rating agency downgraded the Long-Term Foreign Currency Issuer Default Ratings (LTFC IDRs) of 24 Turkish banks and their subsidiaries, in most cases by two notches.

On July 13, Fitch cut Turkey deeper into junk, downgrading its Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'BB' from 'BB+' with a negative outlook. It said the downgrade was driven by increased downside risks to macroeconomic stability and the recent deterioration in economic policy credibility. 

Bloomberg Survey Estimates on Turkish lenders' Q2 profits
	Q2(Average Estimate)	Q2-2017
Garanti	1.84b	1.57b
Akbank	1.53b	1.51b
Isbank	1.45b	1.25b
Yapi Kredi	1.12b	892m
Vakiflar	1.06b	865m
Halk Bank	1.08b	1.01b
Average	1.35b	1.18b