Rupee Forward Premium Touches Nearly Six-Month High As Fed Rate Cut Hopes Rise

Premiums on one-year exact dollar/rupee forward contracts were trading at a six-month high on Monday, as US treasury yields declined and banks persistently bought the greenback for forward delivery, according to forex traders.

The market's increasing optimism about a potential rate cut in the US by the September meeting is set to widen the interest rate differential between the two countries, causing the spike in premiums, said Amit Pabari, managing director, CR Forex Advisors.

On Tuesday, the premium on one-year exact dollar/rupee forward contracts rose to 1.84%, the highest level since Feb. 2. It was at 1.83% as of 3:09 p.m. according to data on Cogencis.

Interest rate differential is expected to go up between the US and India, in case Federal Reserve starts to reduce interest rates as the Reserve Bank of India may take time to reduce rates, according to traders.

Forwards of a currency pair reflects interest rate differential between the two countries.

The US PCE index, the Federal Reserve's preferred inflation gauge, increased 2.5% in June, as compared to 2.6% rise in May. On a sequential basis, it rose 0.1% in June after being unchanged in May, matching Reuters' forecasts.

Fed fund future traders have priced in a 89.6% probability of a 25-basis-point rate cuts in September, as compared to 57.9% possibility a month back, CME FedWatch tool showed. The current Federal fund target rate is at 5.25-5.55%.

Following the US PCE data, released on last Friday, the yield on the benchmark 10-year US Treasury fell to 4.15% on Monday, touching the lowest level in over one week, according to Bloomberg data. It was at 4.18% as of 3:09 p.m.

It continued to trade near the one-week low as traders await the outcome of Federal Reserve Open Market Committee policy meeting, scheduled for release late on Wednesday. The FOMC is largely expected to opt for a dovish hold in this week's meeting, according to forex traders.

Meanwhile, some banks sold the greenback for forward delivery to book profit from higher premiums, which limited further gains, according to forex traders.

In the short term, significant changes are unlikely, but over the next six months, the annualised premium is expected to range between 1.75% and 2.05%, Pabari said.

The Indian rupee continued to post fresh lows against the greenback on firm dollar demand in the domestic spot market. It was trading at around 83.72 a dollar as of 3:09 p.m., as per data on Cogencis.