1-yr dollar/rupee fwd premia hit 11-week low as US rate cut seen delayed

RBI likely to take delivery of the dollar-rupee sell buy swap on March 11

Premiums on one-year dollar/rupee forward contracts fell to their lowest level in 11 weeks (since December 11, 2023) on Wednesday to 1.65 per cent.

Premiums have been falling for the past few trading sessions as rate cut expectations by the US Federal Reserve is being pushed back, and traders are taking positions ahead of the $5 billion dollar-rupee sell/buy swap maturing on March 11, said market participants.

The premiums on one-year dollar/rupee forward contracts have declined by 22 basis points (bps) in February so far, due to the shift in rate cut expectations, initially anticipated for March but now postponed to May. The likelihood of a rate cut in May is also diminishing. The premium had settled at 1.67 per cent on Tuesday.

Consequently, the yield on the benchmark 10-year US Treasury bond rose by 33 bps in the same period.

According to CME’s FedWatch tool, investors are now expecting an 81 per cent probability of the US rate-setting panel maintaining the current rates in May. This is a notable increase from the 65 per cent estimate observed a week ago.

“The forward premium is mainly influenced by the interest rate differential between the US and India. The 10-year bond yield in India is now 7.06 per cent and in the US it is 4.29 per cent. This shrinking rate differential is causing the fall in forward premium,” said V K, Vijayakumar, chief investment strategist at Geojit Financial Services.

Additionally, traders expect the Reserve Bank of India (RBI) to take delivery of the $5 billion dollar-rupee swap, leading to a shortage of dollars in the system.  

“The RBI swap of $5 billion is maturing on March 11 and the market is expecting the RBI to take delivery of dollars due to tight rupee liquidity conditions. This may lead to a shortage of dollars in the market. Hence, good receiving is happening in forward premiums,” said V R C Reddy, head of treasury, Karur Vysya Bank.

If the central bank opts to receive the forward dollars, it would withdraw $5 billion from the financial system while injecting approximately Rs 400 billion of rupee-denominated liquidity, based on prevailing exchange rates.

In March 2022, the central bank had engaged in a $5 billion sell/buy swap, selling dollars while agreeing to repurchase the same amount at the swap's end. This move aimed to extend the maturity profile of the forwards book and streamline receivables tied to forward assets.