"The market is only pricing 2% inflation in 15 years"

A guy just said this on Bloomberg. he said they derived it from inflation swaps.

What's he talking about and how does one do that?

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Comments (8)

Mar 10, 2016

The rates on inflation swaps in the mkt allow one to compute the mkt's "expectations" for future inflation (with a whole lot of caveats). FWIW, I don't see this in 15y, but rather in smth like 8, based on the US CPI swap mkt. Again, keep in mind that these things are rather tricky, so take whatever you hear with a large pinch of salt.

Mar 10, 2016

Guy was talking about Europe.
I have two questions,
1. any resource where i can learn how to do this ? go from inflation swaps quotations (can i find these on bloom ? we have it at school) to this time based "expectation"
2. What's the market for inflation swaps ? who buys these things and to hedge against what ? Can't i just use treasury bonds to hedge against inflation given that the empirically proven fisher equation says that (give or take 6 months) the nominal interest rate = inflation + gdp growth ?

Mar 11, 2016
  1. Well, there is a screen called SWIL on Bloomie. This gives you the mid rates for spot starting inflation swaps of various maturities. From that you can either calculate the appropriate fwd rates (e.g. 1y 1y fwd, 1y 2y fwd, etc), or maybe there's a screen that does it for you directly (I don't recall, since I don't use Bloomie for these). These fwd rates correspond to the mkt's risk-neutral expectations of where 1y inflation will be in 1y, 2y, etc.
  2. The inflation derivatives mkt, along with the inflation-linked bond mkt, is relatively well-developed. People buy and sell these things to hedge inflation risks. And no, you can't really "hedge" inflation with nominal treasury bonds, Fisher equation or not (let's not even talk about the "empirically proven" bit). Nominal bonds have, at best, an indirect relationship with inflation, which means you need something where the cash flows are directly linked to the appropriate price index. That's where I-L bonds and derivs come in.

And, btw, if the guy was talking abt Europe, it's strange. I don't see any numbers with a 2 handle in European inflation swaps. Maybe I was looking at it wrong...

EDIT: No, I was looking at it right. There's really no 2% inflation to be seen in EUR HICP.

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Mar 10, 2016

Just look at the difference in yield between TIPS and traditional Treasuries from the same maturity. That gives you the best estimate of the market's expectations of future inflation.

Mar 10, 2016
DickFuld:

Just look at the difference in yield between TIPS and traditional Treasuries from the same maturity. That gives you the best estimate of the market's expectations of future inflation.

Nein nein nein!

Given the various structural issues with both the TIPS and the nominal UST mkt, this currently is likely to be the worst estimate, in fact. As I am sure other people have told you before, you, Dick, are living in the past.

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Mar 10, 2016
Martinghoul:

DickFuld:Just look at the difference in yield between TIPS and traditional Treasuries from the same maturity. That gives you the best estimate of the market's expectations of future inflation.

Nein nein nein!

Given the various structural issues with both the TIPS and the nominal UST mkt, this currently is likely to be the worst estimate, in fact. As I am sure other people have told you before, you, Dick, are living in the past.

I doubt he's going to be calling dealers for a quote or check his Bloomberg terminal in his dorm room.

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Mar 10, 2016

True dat... It's some talking head on TV at any rate.

Mar 12, 2016
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