WHEN ITALY JOINED the e70 billion European inflation-linked bond market last year with a five-year issue, investors welcomed the move and banks highlighted it as a trigger for a wave of new interest in the instruments.
But the success of the deal was not driven by demand for five-year inflation in itself. Rather, because so many market participants had been using inflation-linked derivatives, they needed to hedge their exposure with five-year paper. That meant that derivatives desks were among the most active buyers of the bonds.
This relationship between inflation-linked bonds and the related derivatives is peculiar but, thanks to the relatively good development of the long end of the curve, it is unlikely to spark issuance at other maturities.
Imbalances
"When you are trading derivatives the question is how to hedge them," explains Philippe Challande, an inflation trader at BNP Paribas. "Do you have a bond or do you take...
