In the over-the-counter world of inflation derivatives, the conclusion is U.S. inflation won't come down fast enough to avoid more upset in the broader market.
For the past 20 years, Gang Hu has traded Treasury inflation protected securities and related derivatives instruments, working for big firms like PIMCO and Barclays before starting his own New York hedge fund, WinShore Capital Partners. During most of his career, inflation wasn’t much of a factor in financial markets and few took notice of what traders like Hu were up to in the so-called fixings market.
“Right now, the Fed is running against time,” the Shanghai-born trader said. “Inflation better slow down quickly and if it doesn’t come down by September, the Fed will have to probably get rates to around 2.75%. A soft landing depends on a quick turn south of inflation and expectations. But there’s no reason to expect that inflation will come down that fast. And every time we get another strong print, that feeds into the real economy or general psychology.
“I don’t think we’re going back to the old regime of disinflation, but I do think inflation is going to be stickier than most people imagine,” said Chris McReynolds, head of inflation trading at Barclays UK:BARC, which trades fixings as a market maker. For the past year, though, it has been inflation-derivatives traders who foresaw a more aggressive path for U.S. inflation and they have been incredibly accurate with their forecasts. For example, they’ve refused to call a peak in inflation like many others in the financial market, and have foreseen each meaningful leg higher in the annual headline CPI rate since it started breaking away in April 2021: They called inflation’s move toward 6%, 7%, 8% and 8.
If those expectations for the next handful of months play out, that would be enough to further upset financial markets, said Dec Mullarkey, the Wellesley, Massachusetts-based managing director of investment strategy and asset allocation for SLC Management, which oversaw $268 billion as of March. Inflation derivatives haven’t always turned out to be completely accurate — the sector can be behind the curve whenever the government changes its methodology or data sources for calculating inflation, as was the case in March 2017, September 2018, and March 2019, according to Pasadena, California-based analyst Omair Sharif, founder and president of Inflation Insights, who has tracked the sector’s track record.
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