September 2008 Archives

Because I am an inflation derivatives trader, people generally expect me to be a big bull on inflation. Certainly, some entire Wall Street firms are structured so as to encourage the expectation that inflation is going to surge so investors should buy TIPS! But my view tends to be more agnostic: inflation-linked assets are an important product regardless of where inflation is going in the next week, month, or year, because all investors are sitting by default in nominal space and are making an implied bet on inflation (that it will remain low); many of them should not be making that bet. I think of inflation protection as insurance against an unlikely outcome: people buy fire insurance on their homes all the time even though they aren't expecting them to burn down. But one inflationary debacle and your wealth just went up in smoke.

I entitled this comment provocatively, but my real point is that if we are inflation-indexed, the whole point is that we are immunized against inflation. We don't care which way it is going. We are trained to think of buying TIPS as being a bet on inflation, but in fact it's the other way around: holding nominal assets is the bet; to own TIPS is to be neutral on the matter.