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Chapter 7 - Fixed Income Arbitrage > 7.9 BREAK-EVEN INFLATION TRADES
7.9 BREAK-EVEN INFLATION TRADES
A break-even inflation trade is executed to take a view on the market’s expectations in terms of inflation and it employs a relatively recent type of treasuries, whose yield depends on inflation.
Treasury Inflation Protection Securities (TIPS) are treasuries with a floating rate that depends on the inflation rate and are issued to protect investors from an inflation surge. The coupon’s initial rate is fixed below the rate of treasuries having a similar maturity; later on, if inflation goes up, the yield of these securities will follow suit.
If the hedge fund manager believes that inflation will rise, the deal is established by buying TIPS and selling traditional treasuries short, so as to construct a position that is not correlated to interest rates. Vice versa, if the fund manager believes that inflation will go down, he will short sell TIPS and buy traditional treasuries.
