(Bloomberg) -- Traders are more bearish than ever on the Turkish lira on expectations that market forces will eventually overwhelm government exchange controls.

Traders are already testing policymakers’ resolve. The lira slid past 20 against the dollar for the first time in Istanbul on Monday, weakening as much as 4.1%, before wiping out the losses to end the day little changed. The currency fell briefly beyond the 20 mark again the following day, before paring its drop. 

That resilience hasn’t stopped traders ramping up bets for a steeper decline in the lira. Options traders see a 54% probability that the currency will weaken to 29 per dollar in the fourth quarter, which would amount to a depreciation of 32%. That’s higher than the 36% odds of such a move that traders saw on May 15, when results of the first round of voting in Turkey’s presidential election were announced.

“There are clear signs that the Turkish authorities’ policy of artificial lira stabilization is under increasing pressure,” said Ulrich Leuchtman, head of FX research at Commerzbank AG. “We see those episodes of short-term jumps with increased frequency and intensity.” 

The extra cost to protect against lira declines in the coming six months — versus hedging against gains — closed at a record high of 19 percentage points on Monday, almost doubling from 10.7 in January, according to risk reversals. It stood at 18 on Tuesday.

That jump comes after President Recep Tayyip Erdogan won the support of a nationalist rival eliminated in the first stage of the contest, boosting his chances of extending his 20-year rule in Sunday’s runoff. 

The central bank asked some local lenders to reduce their daily foreign-currency purchases on the interbank market by an additional 25% on Monday, according to people with direct knowledge of the matter, who asked not to be identified because the talks were private. The bank declined to comment.

Concerns are growing among global investors that government policies — ranging from state intervention to interest-rate cuts in the face of surging inflation — could inflict more pain on the economy. Alternative measures adopted to stabilize the lira have made it among the least volatile currencies in emerging markets in the last six months.

What Bloomberg Economics Says... 

Given the build up in fragilities, monetary policy is likely to become more orthodox regardless of the presidential election outcome. The central bank will likely tighten, and move away from a web of alternative tools. Turkey’s inflation problem, on the other hand, will likely be around for a while, and dark clouds loom over the lira in the short term.

— Selva Bahar Baziki, economist. Click here to read more. 

Efforts to stabilize the lira are “unsustainable,” said Peter Kisler, a London-based hedge fund manager at Trium Capital. Erdogan “will need to raise rates and/or weaken the currency.”

“With a high probability of Erdogan’s re-election, the day of reckoning for Turkey’s economic policy beckons,” said Hasnain Malik, a Dubai-based strategist at Tellimer, a provider of research and data on emerging markets to investors. “A mix of high growth, hyperinflation, deeply negative real interest rate, near-zero net foreign reserves, and stable currency is unsustainable and something will have to give.”

--With assistance from Kerim Karakaya.

©2023 Bloomberg L.P.