The inflation market has had a challenging 18 months since the collapse of Lehman Brothers in September 2008. In the immediate aftermath, banks sold inflation-linked bonds that had been used to hedge swaps as part of a general reduction of balance sheets, while investors switched out of inflation-linked bonds in favour of more liquid nominal bonds, creating a significant cheapening of linkers relative to nominals. Liquidity in the swaps market also dried up significantly. Meanwhile, dealers were wrestling with short positions in 0% inflation floors, creating sizeable losses for some.
This roundtable explores how the inflation derivatives market is recovering and building momentum in the current challenging economic environment. Questions answered by the participants include:
1: Is liquidity now back to pre-Lehman levels in UK, US and euro inflation?
2: Can you describe some of the main factors that have driven the inflation market this year?
3: The asset swap market was very active last year, with investors keen to take advantage of an anomaly between nominal and inflation-linked bonds on asset swaps. Has this anomaly now completely disappeared? Are there still opportunities to put on this trade?
4: Can you comment on the outlook for supply for the coming year? Emerging markets in particular have suffered quite a lot over the past couple of years, with several countries delaying inflation-linked bond issuance. Do you see these markets returning this year?
5: Quantitative easing has split opinion on how it is going to impact inflation in future. How has this influenced trading strategies?
6: Inflation dealers have often needed to warehouse large amounts of risk until the other side of the trade comes along. With pressure on banks to reduce balance sheets, has this curtailed the business dealers are able to take on?
7: Where do you see the market going over the course of this year? What are the key opportunities and risks?
Participants in the roundtable included:
Nick Sawyer, editor, Risk magazine
Mark Capleton, head of inflation research, Société Générale Corporate & Investment Banking
Jim Hough, head of euro inflation, Royal Bank of Scotland
Daragh McDevitt, global head of inflation and property derivative structuring, Deutsche Bank
Dariush Mirfendereski, head of inflation-linked trading, UBS