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Informist, Tuesday, Aug 6, 2024

 

By Sourabh Kumar and Kabir Sharma

 

MUMBAI – Dollar/rupee forward premiums have been on a steady climb throughout last month as the interest rate differential between India and the US is seen widening due to rising odds of a rate cut by the Federal Reserve in September. Now, with the latest round of economic data from the world’s largest economy building a case for the Fed to loosen its policy more aggressively than previously expected, the one-year forward premium has scaled a 14-month high of 2.09%.

 

A slew of economic data from the US has raised expectations that the US economy is finally cooling off, perhaps at a more rapid pace than the Fed would like. The latest of these has been data released Friday indicating a rise in the US unemployment rate to 4.3% in July from the previous month's 4.1%. This has cemented the view of multiple rate cuts by the US Federal Reserve in the coming months, starting with a solid 50-basis-point cut at the meeting on Sep 17-18.

 

Fed Funds futures now reflect an almost 75% probability of a 50 bps rate cut at the US Federal Open Market Committee’s September meeting, up from around 13% seen a week ago.

 

Expectations of a rate cut in September were building up since the start of the last month, when several economic data from the US, including Purchasing Managers' Index started coming in softer than expected. Further, at the latest FOMC meeting decision on Jul 31, while the fed funds rates were kept steady at 5.25-5.50%, Fed chair Jerome Powell indicated a possible rate cut in September, should inflation keep moving down.

 

With the Fed expected to go for a 50 bps rate cut in September, and no sight of a rate cut by the Reserve Bank of India yet, the interest rate differential between the US and India is likely to rise, thus, driving dollar/rupee forward premiums higher. Premiums on forwards of a currency pair are reflective of the interest rate differential between the two countries. The RBI’s monetary policy committee, which will conclude its three-day meeting on Thursday, is widely expected to stay pat as headline inflation remains well above the target level of 4%.

 

Dollar/rupee forward premiums have been rising also due to an increase in demand for forward dollars to hedge against rupee depreciation after the rupee fell to successive record lows over the past few weeks, dealers said. The rupee has weakened 0.6% against the dollar in the spot market since last month.

 

In the past few weeks, as the RBI has allowed the rupee to depreciate, not only did it give wiggle room to trade the dollar/rupee pair across segments, but also shook unhedged importers out of their complacency. In the spot market, the rupee fell to a record low of 83.9650 a dollar today from 83.44 a dollar at the start of July. During this period, the one-year forward premium has risen over 42 bps.

 

Market participants said the intervention by the RBI also aided the rise in forward premiums. The central bank is said to have actively intervened in the forwards market via sell/buy swaps to neutralise the liquidity impact of its earlier dollar purchases, when it went about absorbing foreign fund inflows into the debt market. Since Jun 28, when Indian bonds got added to JP Morgan’s emerging market index suite, foreign portfolio investors have bought government securities worth 239.6 bln rupees.

 

"Besides importers, the central bank was also likely paying in the forward market instead of intervening in the spot to avoid the gush of rupee liquidity," V.R.C. Reddy, head of treasury, Karur Vysya Bank.

 

As investors assessed the possibility of a rate cut by Fed and the RBI's increasing involvement in dollar/rupee forward market, surplus liquidity conditions did little to soften premiums, market participants said. Last month, liquidity in the banking system remained in surplus, with most of the days near or over 1 trln rupees, and touching 2.86 trln rupees on Monday, the highest since Jul 6, 2022, according to the data by the RBI.

 

With widespread expectations of the Fed cutting rates, market participants expect premiums to keep rising. Moreover, they said it remains to be seen if the RBI changes its stance in the upcoming monetary policy meeting or not. In the case of RBI not going for a rate cut this year, or not following the Fed in cutting rates, it could prove a positive for the premiums, and that could keep the dollar/rupee forward premiums elevated, market participants said.

 

"I am expecting US yields to keep falling, now that the expectations of rate cuts by Fed is rising. Therefore, I see 1-year premiums to rise to 2.25%, and that is a resistance level, from where it could bounce back," Sajal Gupta, executive director and head of forex and commodities at Nuvama Institutional Desk said.  End

 

US$1 = 83.9525 rupees

 

Edited by Deepshikha Bhardwaj

 

 

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