Crossing the floor
The inflation market has experienced a severe dislocation, with breakevens plunging during October and November. It has left dealers scrambling to hedge their exposures to 0% floors embedded in structured notes. By Duncan Wood
As 2008 came to a close, inflation desks found themselves caught between a rock and a hard place. Falling inflation expectations made it prudent to hedge their exposure to deflation - accumulated over a five-year period during which banks sold 0% inflation floors cheaply. However, an unopposed wave of hedging in October and November crushed the front-end of the forward inflation curve, simultaneously amplifying the industry's short floor exposure and making further hedges of dubious value. Faced
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