Dollar/rupee forward premia falls in two weeks after Fed rate cut expectations wane

Forward premia

Forward premia on the dollar/rupee forward contracts fell in the last two weeks as rate cut expectations by the US Federal Reserve is seen delayed, money market experts said.

The forward point is the interest rate differential between the two countries. These points are added to or subtracted from the spot rate. A spot rate is the price quoted for immediate settlement of a currency trade. An addition of a forward point to the spot rate is called a forward premium, and a subtraction is called a forward discount.

“The one-year implied yield (forward premiums) overall fell towards 1.66 percent after market participants seem to be dialing back rate cuts for the year, with the September rate cut probability also going to 50-50 now as per the CME Fedwatch data,” said Kunal Sodhani, Vice President, Shinhan Bank.

Dilip Parmar, Research Analyst, HDFC Securities, said that due to the narrowing interest rate differential and lower volatility, the forward premium is declining.

US data showed persistent strength in the labour market and business activity, prompting investors to reduce the probability that the Fed will cut rates later this year. Initial US claims for state unemployment benefits dropped more-than-expected and US business activity accelerated to the highest in more than two years in May.

The activity data highlighted improving growth momentum at the mid-way point of Q2 and the need for ongoing caution with respect to monetary policy, ANZ Bank said in a note.

Odds that after the Fed's September meeting, the policy rate will remain at the current level of 5.25-5.50 percent were up to 46 percent, as per CME FedWatch Tool.

Sodhani said that the FOMC Minutes, US data points and a slew of Fed speakers are all pointing towards a hawkish stance, which means rate cuts may still not be certain and will remain data-dependent.

Also read: Citi sees rupee a favorite in Asia as India joins key bond index

According to Bloomberg data, the premium on the one-year dollar/rupee contract was 137.60 paise on May 31, compared to 145.65 paise on May 8.

Similarly, the premium on the six-month dollar/rupee contract was 57.45 paise on May 31, as against 60.3 paise on May 8.

The forward premia on the three-month and one-month dollar/rupee contract was at 24.45 paise and 7.55 paise on May 31, respectively. This was lower, as compared to data on May 28.

Indian rupee and the yields on government securities are expected to react negatively on June 4, if the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) fails to secure 300 seats in the Lok Sabha elections 2024, money market experts said.

Election results are set to be announced on June 4. The Lok Sabha has 543 seats. The President of India maintains the authority to nominate a maximum of two members to represent the Anglo-Indian community.

If the opposition INDIA bloc secures a majority, it will hit the rupee severely and it could touch the 85-mark against the US dollar, experts said.

Also read: Goldman sees India’s stocks, bonds and rupee as top emerging market picks

Experts are of the view that if the Reserve Bank of India (RBI) keeps intervening in the forward market, the forward premia may decline further.

“If the RBI is engaged in selling dollars in forwards, as witnessed by the recent dip in the forward book, the premiums tend to decline. Well, the future trajectory of the premiums heavily depends on the central bank's action,” said Amit Pabari, Managing Director, CR Forex.

Further, Sodhani said election results definitely remains a pivotal event watch, starting from the exit polls to the election results to the 100-day government agenda to the July budget. This will define capital flow to India, which, in turn, remains vital for the direction of the rupee.