FxWirePro: Hedging alternatives of USD/INR apart from RBI’s swap contracts ahead of Fed, liquidity-infusion to reduce hedging costs

The US Fed meeting tonight is the today’s key focus and the broad USD is holding support levels as are US yields as we head into the event even though the interest rates would likely be left unchanged for the second successive meeting. 

Moreover, the key message will continue to be that the Fed will be “patient” before considering any further changes to policy. That suggests the ‘pause’ will last for at least several more months.

Nevertheless, the Fed still faces a couple of tricky issues. First, it needs to update its economic forecasts which were last reviewed in December. In particular, FOMC members will present a new set of interest rate forecasts, the so-called ‘dot plot’. Markets expect a downward revision to these. Indeed, some FOMC members may feel that they can best convey their position by forecasting no further rate hikes.

On the flip side, there is a noteworthy event to add in our calendar among EMFX space. Reserve Bank of India’s upcoming USD5bn swap deal which is scheduled on March 26thneeds to be observed in a context that the deal should be perceived as a new instrument to infuse liquidity and not as a tool to influence the exchange rate. Theoretically, the RBI’s purchases of US dollars from banks in exchange for rupees should work against further appreciation via the fall in the implied yield for the longer-dated USDINR forwards.

In order for hedging against Indian rupee depreciation risks in the interim, banks will pay (swap) costs which will be arrived at the auction; this safeguards the banks. On the central bank’s part, existing reserves provide ample cushion. 

Varying from the 2013 swap arrangement, banks are unlikely to receive subsidized swap costs this time around, given a stable rupee and reserves buffer.

Apart from diversifying liquidity-infusion efforts, this measure is expected to ease longer-tenor forward premia, helping to lower hedging costs. This is opportune considering recent changes to external commercial borrowing limits, particularly for state-owned oilers, the introduction of the VRR investment route for portfolio investors and better foreign flows. Indian corporates have also shown a strong appetite for USD fundraising this year, with YTD issuances at a record of USD4.8bn for this period, according to Bloomberg, due to compression in US-IN spreads. On the side, this move is also seen as a pre-emptive step to absorb strong imminent M&A related inflows and thus limit gains in the currency.

Reaction in the rupee (helped by a soft dollar and strong inflows) and bond markets has been positive; INR is up 1.8% vs USD year-to-date vs -2.8% earlier in the year. Bonds gained considerably as yields of the most-traded 2028 INR sovereign bond tested below 7.5% and (generic) 2Y yields below 6.6%. If this near-term correction in yields gains traction, banks might be able to improve their marked-to-market balances ahead of the end-fiscal year close.

Short positions in this pair have already been advocated, we prefer to uphold those positions on USDINR at spot levels, stop loss at 69.13 for targets of 68.58 or even up to 68.34/67.88 levels. Courtesy: DBS & Lloyds

Currency Strength Index: FxWirePro's hourly USD spot index is inching towards -26 levels (which is mildly bearish), while articulating (at 13:02 GMT).

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex