Inflation derivatives house of the year: Citi

Risk Awards 2023: Dynamic risk limits and long-dated bonds help Citi supersize client trades and boost inflation business

Left to right: Richard Yang, Bari Spielfogel, Deirdre Dunn, Nikolay Stoyanov
Left to right: Richard Yang, Bari Spielfogel, Deirdre Dunn, Nikolay Stoyanov
Alex Towle

Inflation came back with a bang in 2022. A series of stress events, headlined by February’s Russian invasion of Ukraine, blew out levels already on the rise across the globe.

Against this macro backdrop, increased demand for inflation protection products came as no surprise. But being able to satisfy client demand consistently – and at scale – would be remarkable. Citi was up for the challenge.

“We’ve seen more inflation market activity this year than ever before,” says Pedro Goldbaum, global co-head of rates at Citi. “I’m incredibly proud of our team for always being able to execute trades and service clients, despite the multiple stress events they were working against.”

Citi says the diversity of its client franchise enables it to consistently source inflation protection throughout the year, while its large balance sheet and increased risk appetite meant it could warehouse directional risks where others couldn’t.

We’ve seen more inflation market activity this year than ever before
Pedro Goldbaum, Citi

In a year beset by multiple challenges of their own, clients appreciated Citi’s approach.

“Citi is always open to taking on more risk and warehousing that risk to make sure we can get the trades we need done,” says the head of LDI [liability-driven investment] at a British pension fund.

“The ability to warehouse risk has become an increasingly rare commodity across the Street over the last couple of months, so knowing we can always go to Citi with a decent size ticket is really valuable to us as a client.”

Preparation had helped the bank to deliver this service when the sterling markets went into crisis late in Q3.

Citi’s ability to manage a largely one-way demand for inflation protection was tested throughout the year, but never more so than in September, when a change in UK premiership brought the particular challenge of then-Chancellor Kwasi Kwarteng’s ill-received mini budget.

On September 23, markets reeled at the announced raft of tax cuts that many thought would presage an increase in UK government debt – a perception that pummelled gilts and within three days provoked a 96-basis point spike in 10-year yields. The pound also took a pasting and the sterling/US dollar spot rate slumped by roughly 14% in the same timeframe.

This dislocation raised fears that the Bank of England would find it harder to prevent UK inflation rising further – and turbo-charged demand for inflation protection products. Citi rose to meet the demand.

Deirdre Dunn
Alex Towle
Deirdre Dunn, Citi

The bank’s head of sterling trading, Siuyan (Su) Liu says her team had run scenarios of what a UK fiscal announcement could look like, and the impact it could have on UK government bond supply. So, when markets started to move on the back of the announcement, Citi’s strategy was already in place.

Integration and co-ordination across desks and businesses were key to its approach.

The inflation desk was aided by the close relationship with other interest rate desks at the firm. Traders typically sit back-to-back on the trading floor and are jointly overseen by Goldbaum and global co-head of rates Deirdre Dunn.

So, when Citi’s inflation clients were also looking to trade sterling interest rate products, the frequent interactions between the two desks helped traders offset sterling inflation trades with sterling rates trades – at a time when market liquidity was particularly shallow. These offsets allowed the firm to continue executing client trades throughout stressed periods and minimise overall market impact.

With more challenging conditions for inflation market liquidity in September and October, more of Citi’s clients sought to execute larger trades in their entirety to minimise slippage risk and improve execution in the face of wider bid/offer spreads. Citi was quoting trade sizes in the millions of pounds of IE01 – the sensitivity to a one basis point move in underlying inflation – during this period.

Left to right: Su Liu, Bhaavit Agrawal, Pedro Goldbaum
Left to right: Su Liu, Bhaavit Agrawal, Pedro Goldbaum
Geraint Roberts

This contrasts with more typical behaviour – clients usually seek to execute smaller trade sizes in multiple clips to help keep the bid/offer spread as narrow as possible.

In filling this need for larger trades, the UK inflation desk became more comfortable taking on additional risk and providing a greater warehousing service for clients.

As inflation became a global macro theme, fixed income markets became more closely correlated, and Citi sourced inflation protection with alternative – and typically more liquid – markets using a range of proxy hedges.

Leaning on other markets in this way leaves Citi with a “reasonable amount” of correlation risk, according to inflation derivatives trader Nikolay Stoyanov, which it actively manages until it is able to unwind these positions.


Citi also met the surge in client demand by adopting a dynamic approach to its inflation business risk limits – providing liquidity with trades that exceed typical market sizes.

In September, for example, one of its clients was looking to flip its €1.5 billion ($1.63 billion) notional of inflation-linked bonds into euro inflation swaps on the back of hawkish comments from the European Central Bank – which saw inflation-linked bond spreads significantly widening against inflation swaps.

Convinced that no single bank would be able to execute the entirety of its trade – given that liquidity was shallower and more sensitive to multiple trades – the client intended to execute smaller clips across multiple banks. But Citi demonstrated that it could trade the full amount, thanks to its ability to transfer or warehouse risk, and that by executing the trade entirely with Citi, the client would be shielded from adverse market movements.

Douglas Cypel
Douglas Cypel, Citi

The bank took on the full €1.5 billion, executing several smaller clips with multiple counterparties in a mix of core and non-core inflation-linked bond trades, trading around €200 million in inflation-linked bonds versus inflation swaps every day over several days.

“Our pitch to the client was essentially that we’re a trustworthy counterparty … able to handle the entirety of this trade for them,” says Douglas Cypel, head of euro inflation trading at Citi. “[This] prevented a negative impact on overall market liquidity, which would have negatively affected both the client and the banks printing the flow.”

It’s a pitch that worked regularly for Citi last year. The bank says it executed multiple inflation swaps in clips, exceeding the conventional market size by as much as 10 times in the European inflation market alone – trading several clips at a time of “a couple of million” of IE01 in different regions.

Option to grow stateside

Citi’s approach has also helped it grow in the US inflation options market – where it has traded over $5 billion in volume since the Covid pandemic with distributor, investor and corporate clients around the world.

Unsurprisingly, most of Citi’s standalone US inflation options flow since the pandemic has been driven by clients’ increased need for inflation protection – predominantly inflation caps. This contrasts with the flow Citi was seeing pre-2020, when standalone inflation floors, offering protection from a deflationary market environment, were the most requested product type.

The product is illiquid and hard to hedge, meaning Citi had to get comfortable with the fact that any risks associated with trades could be sitting on its books for some time.

Nikolay Stoyanov
Alex Towle
Alex Towle

Stoyanov’s team conducted a significant amount of scenario analysis to work out the amount of risk Citi would likely be taking on from trading inflation caps – as well as analysing the potential hedging strategies it could deploy to minimise such risks.

As part of this, the team analysed how much correlation existed between inflation volatility and volatility in other markets – such as liquid interest rates – further helping Citi to get comfortable in providing inflation caps due to the potential correlation hedging that could be completed.

Over the past year, Citi’s dynamic risk limits allowed Stoyanov to increase the amount of inflation caps his desk has been able to facilitate for clients over the medium term.

“All of which has allowed us to increase the amount of liquidity we can provide to clients in these products, when market liquidity is minimal at best,” says Stoyanov.

“In volatile markets, it’s usually very hard and painful to provide a continuous price to clients, but our philosophy is that we want to be a long-term and reliable counterparty,” he adds.

“Citi has consistently been one of our largest counterparties for the last four years,” says one managing director at an American asset management client. “They’re incredibly consistent in the way that they price inflation derivatives – and have been for a very long time.”

Long bonds and talent

Crucially for inflation protection offerings in 2022, the firm issued a series of long-dated inflation-linked bonds in multiple currencies – sterling (20+ years), US dollars, euros and both Mexican and Chilean pesos. As the bonds’ principal increases in line with local inflation, the real impact of inflation is softened for any bond-holding client.

Citi was one of the only banks on the Street to issue such bonds in 2022 and by the end of Q1 had issued £130 million in long-dated sterling inflation-linked bonds alone – contributing to a “high double-digit” overall percentage growth in the number of fixed income structured notes issued at Citi in 2022 compared with 2021.

The firm says the coupons had a positive real rate – the normal ‘nominal’ rates minus inflation, plus Citi’s credit spread – proving attractive to investors because they were higher than UK inflation-linked bonds. By the end of 2022, Citi had issued 25 bonds totalling more than $500 million across multiple regions.

“In 2022, many distributor and real money clients were looking for securities which would give them inflation protection, given the macro uncertainty and increase in inflation,” says Bhaavit Agrawal, global head of rates and currencies structured notes at Citi. “Citi arranged many inflation-linked structured notes referencing both [developed] and [emerging market] inflation to meet this client demand.”

The success of Citi’s inflation business this year is also thanks to a raft of new talent. The UK inflation team is new and was hired by Liu, who joined the bank in August 2021 as head of sterling trading from last year’s Inflation Derivatives House of the Year winner BNP Paribas.

Over the past 12 months, Liu has hired five new traders to her team and has restructured the desk to better service clients. The inflation, gilts, swaps and short-term interest rate trading teams were previously headed by different people; 2022 was the first time the UK rates trading team had been under one team leader.

“As inflation has become a global theme, it makes sense to invest in attracting the best people to the desk so that we can continue servicing our clients to the best of our ability on a global scale,” says Goldbaum.

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