By Dhara Ranasinghe, Saikat Chatterjee and Davide Barbuscia
LONDON (Reuters) -Almost overnight, inflation-linked bonds have become the hot ticket in global financial markets, pitting banks against hedge funds in a battle for market share and scarce trading talent.
The $4.4 trillion market for inflation-linked bonds, known as linkers, has shot to prominence as prices spiral higher in a post-pandemic world of supply chain glitches and abundant government spending.
“There is tremendous demand for the product, which is hot, just like green bonds are hot,” said Ben De Forton, head of debt capital markets SSA France at BNP Paribas.
When the United States issued its first Treasury Inflation Protected Security (TIPS) in 1997, inflation was just above 2%, now price growth is running at 7% in the world’s biggest economy and not far behind in Europe.
Investment products whose payouts rise and fall in line with inflation have been around in various forms for several centuries. But in their current one they date to the 1980s when Britain issued its first linker, followed by Australia, Canada, Mexico, the United States and several emerging economies.
But while linkers are hardly new, most fixed income traders in London or New York will have begun working long after the last major inflation flare-up in the developed world, the 1970s.
They will probably have cut their teeth buying and selling bonds against a backdrop of record low price growth.
Even those who have traded linkers are unlikely to have done so daily and in large volumes, with the market previously driven primarily by long-horizon pension and insurance investors.
Orders for a 3 billion euro ($3.43 billion) French linker last month surpassed 23.5 billion euros and almost 200 investors bought in, double the average on past linker deals, France’s debt agency head Cyril Rousseau told Reuters.
Another linker sale last week, by Italy, was almost four times subscribed and France is now exploring a green linker https://www.reuters.com/markets/europe/france-keeps-2022-bond-issuance-plans-steady-eyes-green-linker-2021-12-08.
BULLISH INFLATION PICTURE
“This inflation volatility is driving a real change in volumes and has become a focus in rates for the first time since 2008,” Charles Bristow, global head of rates trading at JPMorgan in London, said of the shift.
Globally the linker market has almost doubled in size from $2.4 trillion a decade ago, but supply remains tight, which along with inflation fears has meant more volatile trading.
Data from electronic bond trading platform Tradeweb shows average daily trading volume of inflation-linked euro area sovereign bonds with a maturity of five years and under was up 90% in January from the same month last year.
Meanwhile, average daily volume on TIPS approached $22 billion last year, the highest on record, the Securities Industry and Financial Markets Association says.
“I’ve been doing this for about 12 years and I’ve always been quite bearish on inflation and for the first time now, we can see a fairly bullish inflation picture globally,” said Su Liu, a managing director in rates trading at Citibank.
“The day is a lot more volatile, a lot busier.”
Outstanding TIPs total $1.6 trillion, but make up barely 8% of the U.S. Treasury debt portfolio, while linkers make up roughly 10% of French and Italian issuance, and 24% in Britain.
But in an indication of the change underway, inflation-sensitive exchange traded products (ETPs) received record investment flows of over $47 billion last year, BlackRock says, equivalent to the cumulative inflow during 2015-2020.
BUMPER REVENUES
As banks tap a rich new revenue seam, the top 15 trading desks globally earned $2.3 billion from trading inflation products, a decade high and more than double 2019 levels, consultancy Vali Analytics estimates.
Growth may be driven by inflation swaps, with traders saying hedge funds are betting on the direction of inflation and single data prints, while insurance and pension investors are increasingly using swaps to hedge inflation exposure.
Colm Murtagh, head of U.S. institutional rates at Tradeweb, said he had “definitely seen” increased demand from hedge funds for inflation swaps launched on its platform last year.
The boom is forcing some firms to beef up desks. One trader, who declined to be named, said the London-based bank he worked for was “aggressively” hiring from mid-tier rivals.
Professional networking site LinkedIn shows hedge funds and banks aggressively adding inflation expertise. A search showed at least five inflation traders have jumped jobs in the last year.
And as central banks prepare an inflation crackdown for the first time in a generation, finding the right expertise is just as crucial for the investment community, said Carl Tannenbaum, chief economist at Northern Trust who worked at the Fed’s risk section during the 2008 crisis.
“Most of your career has been characterized by falling interest rates on the long end,” Tannenbaum said. “And now it looks like we might be starting something, it may not be extreme, but it’s a reversal. So how do you react?”
($1 = 0.8756 euros)
(Reporting by Dhara Ranasinghe and Saikat Chatterjee in LONDON and Davide Barbuscia in NEW YORK; Editing by Sujata Rao and Alexander Smith)
