Rupee volatility, forwards unruffled by Middle East flare up

By Jaspreet Kalra

MUMBAI (Reuters) - Expectations of rupee volatility and the cost of hedging against the currency's decline had a muted reaction to worries over a deepening of the conflict in the Middle East after the U.S. struck Iran's nuclear sites over the weekend.

The reaction across global markets was relatively muted as investors kept their attention on potential retaliation by Iran. The Indian rupee declined 0.2% on the day to 86.8025 per U.S. dollar, tracking weakness in Asian peers.

The currency's 1-month implied volatility, a gauge of future expectations, nudged slightly higher but was hovering near its average over the last two months, signalling that market participants were not yet pricing in the risk of outsized swings.

Markets are wagering that "risk of further escalation seems low", a trader at a large private bank said, pointing out to the quick cooling of crude oil prices after an initial jump.

Brent crude oil futures rose to a peak of $81.4 per barrel but pared gains to quote up 1.7% at $78.3 per barrel.

Dollar-rupee forward premiums, too, reflected limited concern about a sharp depreciation of the rupee. The 1-month forward premium was nearly flat at 11.25 paisa. Far forward premiums also showed a contained reaction.

However, as a large oil-importing nation, India remains vulnerable to risks from sharp spikes in oil prices, MUFG said in a note.

"We would likely revise our USD/INR forecast profile higher if geopolitical risks remain elevated moving forward. Nonetheless, given the weakness already seen in INR, the balance of risks for the currency could be more two-sided."

Dampened risk appetite also weighed on Asian currencies and equities across the board.

India's benchmark equity indexes, the BSE Sensex and Nifty, fell about 0.8% each. The Korean won led losses among Asia FX with a 0.9% decline.

(Reporting by Jaspreet Kalra; Editing by Mrigank Dhaniwala)