Inflation Trade

Reviewed by Annapoorna | Updated on Aug 27, 2020

What is meant by Inflation Trade?

An inflation trade refers to an investing strategy or trading method where a trader wishes to profit from increasing price levels influenced by inflation or expectations of oncoming inflation. Inflation trades are common in times of increasing price inflation or in times when investors expect the Reserve Bank of India to revise rates significantly over the coming months.

Inflation Trade Explained

Inflation trades can refer to portfolio asset shifts, or it may also apply to speculative trades involving assets that are highly susceptible to price inflation, such as the dollar, gold, or silver. Inflation trade refers to a concept widely considered when investors believe there is a risk or potential to profit from rising price inflation. During these times, many investors will rotate their portfolios into assets generally more favourable in an inflationary environment.

Treasury Securities Protected Inflation (TIPS) is a top recommendation for investment portfolios when inflation is on the increase. Sophisticated investors and traders can also conduct targeted speculative trading using derivative tools to orchestrate inflation trading that seeks to capitalise on future price rises.

Inflation is an economic phenomenon which is affected by different market factors. It is typically expressed in percentage terms. It refers to the incremental price increase charged to a consumer for goods or services over a given period.

High inflation can be a detrimental force which erodes money's value. That means that tomorrow people will not be able to buy as much with their money as they can today. Inflation also decreases the impact of investment earnings and makes too much cash holding risky.

Arbitrage in Inflation Trade

Consumers generally have to consider the impacts of inflation on their spending and investment portfolios. Annual inflation in developing economies can be as high as 2% to 3%. Therefore, prudent investors are typically going to make some effort to preserve the value of the wealth they have accumulated and to protect it from inflation.

A lot of investors are advised to add or increase their TIPS exposure in times of rising inflation. TIPS is one of the most popular products for hedging and protecting cash investments against inflationary effects. TIPS offers investors interest payments which over time correspond to the rate of inflation.

In periods of rising inflation, TIPS is usually preferred in investment portfolios over government bonds. Cyclical market industries, such as telecommunications, are another group in which investors typically move into as inflation prices increase. Overall, portfolio inflation trade rotation will help investors outstrip inflation while also growing their upside potential.