Here's How to Profit When the Fed Begins to UnwindBy
Societe Generale strategist touts wagers in swaptions
Euro term premium is seen as too high relative to dollar
Societe Generale SA’s Adam Kurpiel says there is some easy money to be made while the Federal Reserve beings unwinding its balance sheet. Just follow one of the more popular theories in finance, that prices will eventually move back toward the average.
Kurpiel recommends using a mix of swaptions (options on interest-rate swaps) on two- and 10-year rates in both dollars and euros, to bet that the term premium, or the extra yield compensation investors demand above what key variables would dictate on U.S. debt, rebounds to its mean relative to the premium seen overseas.
“The differential in term premiums is quite high from a historical point of view,” the Puteaux, France-based strategist said in a phone interview. “History shows this spread does mean-revert. We can expect some rebound in dollar term premium, which may come on the back of Fed starting to normalize its balance sheet.”
The Fed will begin rolling off its about $4.5 trillion in Treasury and mortgage debt next month.
“Low U.S. dollar term premium to some extent reflects timid market pricing of the Fed’s balance sheet normalization,” said Kurpiel.