Rupee spot plunged on falling forward premiums

Indian rupee spot depreciated by 96 paisa in the previous week and closed at 82.28 against dollar. The move aligned with the forward premium on the USDINR falling by the most in more than a decade. With narrowing yield differentials and RBI intervention in forwards, the yield premium has fallen below 2% compared with 4.5% at the beginning of the year. This incentivizes importer hedging and unwinding of carry trades, further causing cash dollar shortages and propping up USDINR pair.

During the December Monetary policy meeting, RBI raised its key repo rate by 35 bps to 6.25%, as broadly expected, slowing from the three consecutive 50bps increases in prior meetings, and noted that sharper rate hikes are likely to be discontinued. The decision added to 225 bps in rate increases since the start of the bank’s tightening cycle in May, comparatively low to its US counterpart. The RBI also stated that the central bank will raise borrowing costs again to step up efforts against inflation. The central bank maintained its inflation forecast for FY 2023 at 6.7% while revised lower its economic growth to 6.8% from 7.0%.

India’s foreign exchange reserves soared by $11.02 billion to $561.162 billion for the week ended 2nd December, rising for the fourth straight week, to a 3 month high, aided by gains in Foreign currency assets.

The greenback edged higher from a five month low of 104.1 touched early last week, amid upbeat economic data from US. ISM Services data and the solid November jobs report for November pointed to still a resilient economy and bolstered the case for further monetary tightening from Fed. Factory orders for October also surprised on the upside, leading to market reprising of the terminal rates above 5% once again.  Still, the market expects the Fed to deliver a more moderate 50 basis point rate hike at its December meeting following four straight 75 basis point increases.

Outlook for the week: Volatility ahead

This week will be dominated by events, particularly central bank meetings of US, UK and Eurozone. Major events from the US will be the CPI data and FOMC meeting. We have seen a huge unwinding of dollar longs post the October CPI data, which surprised us on the downside. US CPI for November is expected to come at 7.3% YoY. Inflation in the US has been in a downtrend for the last 4 months and if the same happens this time, we might see further weakness in the dollar index on improving conviction that Fed might start cutting rates in 2023.

However, the recent uptick in US PPI data also raised the odds of an upside in CPI data. In case of any higher than expected CPI data (on 13th Dec), we might see short covering in the dollar index on prospects of hawkishness from the Fed in the FOMC meeting (on 14th Dec)Fed is widely expected to hike the benchmark rates by 50 bps in the December meeting. Projections and the press conference are going to be crucial. We expect dot plots to show terminal rates slightly above 5% in early 2023 and zero rate cuts for 2023.

The vital question is what it means for Rupee. If Fed is being hawkish, it might lead to an uptick in the dollar index and US short-term rates. This might lead to further narrowing of India-US yield differentials and we might see the Rupee spot weakening towards 83.5 levels. However, on the contrary, if Fed is being less hawkish and if US CPI eases as expected, then we might see the Rupee spot edging lower towards 81.3 levels in the coming days.

High volatility is expected and thus investors are advised to stay cautious and avoid carrying outright positions.





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