An obscure corner of Wall Street is making billions trading inflation

Small teams have been making the most of global price shocks with volatile trades

Most of the world hates inflation. For Nikhil Choraria and a small band of traders, it’s an opportunity. 

The Goldman Sachs Group Inc. partner is a leading practitioner of the obscure art of inflation trading, a niche business that’s exploded -- very lucratively -- for some of the world’s major banks and hedge funds. 

Choraria, 38 and based in London, orchestrates often-complex transactions designed to profit from gyrations in inflation. Over the past year, his team picked the right side on trades underpinned by the biggest inflationary spike in decades, which convulsed the global economy and even blindsided some central bankers. They helped generate $450 million in revenue in 2021, twice what they made in previous years, according to people familiar with the bank. 

At JPMorgan Chase & Co. in New York, global head of non-linear rates Gil Holmes helped generate about $300 million from inflation trading last year, while traders at Barclays Plc and Morgan Stanley also profited, people familiar with the situation said. In all, the biggest Wall Street banks shared some $2.3 billion from the business in 2021, more than double what they made in 2019, according to data from Vali Analytics Ltd. -- a welcome boost as other kinds of fixed income trading dried up.

There are outsized risks too. The sterling inflation market is known as “the widow maker,” reflecting the danger of becoming trapped in huge losses when traders can’t keep up with the many, messy factors that drive real-world prices. The U.K. market is so small and specialized that a few people moving jobs can make it tricky to find anyone who’s willing to trade. 

It’s not a market for the faint of heart, and not everyone gets it right all the time. But for those who can navigate these challenges, inflation has finally become a goldmine as rising energy costs and snarled supply chains drive up the cost of just about everything.

Surge in trading

Interest rates were left at rock-bottom after the 2008 financial crisis, removing a key factor in inflation volatility and making this business a relative backwater. “Kind of boring,” according to Tim Magnusson, chief investment officer at Garda Capital Partners, a hedge fund that’s traded inflation since about 2006. Now, investors are flocking to protect themselves or speculate on where consumer prices might go from here. 

Average daily trading in inflation-linked government bonds and derivatives is up 30 per cent on a year ago and more than double the level in 2019, according to data from Tradeweb Markets Inc. in London.

“With fixed-income investors becoming more nervous that the zero-interest-rate environment is over, they will have to move toward these kind of investments,” said Peter Hahn, a former banker at Citigroup Inc. who is now emeritus professor at the London Institute of Banking & Finance. “And that will make Wall Street money.”

The US Consumer Price Index climbed to 7.5 per cent in January, the highest since 1982 – before Choraria was born. In the UK, one in 10 may not be able to afford consistent heat and electricity. Governments across the European Union are doling out relief packages to help citizens cope with rising bills. Households from Latin America to South Asia are also dealing with rising prices.

Central banks globally are mulling how much they should jack up interest rates to cool some of this pressure without hampering the economic recovery. Traders are trying to spot the peak. As expectations for UK price rises approach their highest since 2009, concerns in the US and Europe have already begun to ease from last year’s level.   “Inflation volatility has picked up significantly,” said Semin Soher Power, head of inflation trading at Bank of Ireland Group in Dublin.