Forward points are not a fee. Here's what they actually are
On Tuesday morning sterling was trading around $1.3363. If you wanted those dollars delivered next September rather than this week, the forward market would have handed you roughly sixteen pips more, not fewer.
A week ago it would have taken sixteen pips off you instead. Sterling didn't move. The dollar didn't move. What moved is that on Wednesday 16 September the Federal Reserve put its target range up a quarter point, to 3.75 to 4 per cent, and the Bank of England, meeting the next day, held at 3.75 and went home. The gap between the two flipped sign, and every dollar forward quote in the market quietly flipped with it.
None of it was a pricing decision by anyone selling you currency. Worth knowing, because the forward points line attracts more suspicion than anything else on an FX confirmation, and almost all of it is misplaced.
What forward points actually are
A forward rate isn't a forecast. Nobody pricing your March euro contract has a view on where the euro will be in March, and if they do, they're keeping it to themselves.
A forward rate is spot, adjusted for the fact that between now and delivery one of the two currencies earns more interest than the other. Buy euros today and you hold euros at euro rates while giving up sterling at sterling rates. The forward price is simply the number that leaves you indifferent between doing it now and doing it later. If it were any other number you could borrow one currency, lend the other, and lock in the difference, which is the sort of arbitrage that survives about four seconds.
Sterling pays more than the euro at the moment. Bank Rate is 3.75 per cent, held on 17 September by six votes to three, with three members wanting 4. The ECB's deposit rate is 2.50 per cent, effective 16 September. Call it a gap of 1.25 points, in sterling's favour.
So when you buy euros forward, you hand some of that back. That's the entire mechanism. It isn't a charge, and it doesn't reach your provider.
The arithmetic on a two million euro payment
What follows is illustrative. It's built from published central bank policy rates rather than dealt forward prices, so treat the pennies as indicative rather than quotable.
Spot GBP/EUR on 21 September, using the ECB's own published reference rate, was 1.1658. Six months out, the interest differential puts you at about 1.1586. Seventy-two pips worse. On a €2,000,000 supplier payment that's £1,715,600 at spot against £1,726,190 forward, a difference of £10,590, or 0.62 per cent. This is the number that makes finance directors reach for the phone.
Now run it the other way. To have €2,000,000 in six months' time you could buy €1,975,309 today and leave it in a euro account earning 2.50 per cent until it grows into the full amount. That costs you £1,694,420, today.
Or you could do nothing, keep the £1,694,420 in sterling at 3.75 per cent, and buy forward instead.
Six months at 3.75 per cent turns £1,694,420 into £1,726,190.
That is the forward cost. Not approximately. The same number, to the pound. The seventy-two pips is the interest you earned by sitting in the higher-yielding currency, handed back at the far end. You were never charged it. You were paid it up front and didn't notice.
The dollar side just changed sign
Which is why last week matters. With the Fed's range now at 3.75 to 4 per cent, its midpoint sits fractionally above Bank Rate. GBP/USD forwards have gone from a small discount to a small premium. A year out, that's about sixteen pips in your favour rather than against you.
On a million dollars it's roughly £900. Nobody's retiring on it, and it certainly isn't a reason to hedge if you weren't going to anyway. But it's the right order of magnitude to notice, and it swung on a decision taken in Washington by twelve people voting unanimously, none of whom were thinking about your supplier in Stuttgart.
If your provider can't quote you a forward at all, that's a separate problem, and we've written about that one before.
So what do you actually do about it
Three things, none of which need a broker.
Ask for the quote in pieces. Spot, forward points and your provider's margin are three different numbers, and there's no technical reason they can't be shown separately. A provider who'll only give you a blended rate isn't hiding the forward points, which are public arithmetic anyone can reproduce. They're hiding the third number, which is the biggest single driver of what a payment costs you.
Check the points on the back of an envelope. Interest differential, times the fraction of a year, times spot. For the example above: 1.25 per cent, times 0.5, times 1.1658, gives 0.0073. Seventy-three pips against a market showing seventy-two. Close enough to confirm nobody's padding the carry. If a quote comes back a long way from your envelope, the difference is margin, not interest rates.
Get the inputs for nothing. Bank Rate is published at bankofengland.co.uk, the ECB's key rates and daily euro reference rates at ecb.europa.eu, and the Fed's target range at federalreserve.gov. Every figure in this piece came off those three sites this morning, free. For where the rates have been heading, our monthly market update covers it.
On our own position, since it's relevant to whether you believe any of this: Pathfinder isn't directly authorised by the FCA. We work through authorised partners who hold the permissions and safeguard client money, and we don't run a proprietary book. When we tell you what the forward points are, we've nothing riding on whether you agree.
Your forward quote isn't an opinion about sterling. It's arithmetic on what two central banks did last Wednesday and Thursday, and neither of them had you in mind.
Get in touch
If you've got a forward quote in front of you and you'd like a second pair of eyes on it, give us a ring.
Pathfinder FX
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+44 (0)1743 290955
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