Inflation in 2024: What are quants predicting?

Although no quant has a crystal ball, the signs of easing inflationary risk in the US seem promising for the rest of the world. But what does that mean for quant strategies moving forward? A QuantMinds International 2023 panel debated how best to hedge, model and approach this risk in 2024.

A panellist predicted US inflation would “be a bit above 3%” in 2024, which is the figure polled from most economists. But this is still a significant reduction after the rises seen in recent years after the Covid-19 stimuli, the war in Ukraine, and so on, suggesting that inflation has peaked.

The easing of inflation should be replicated globally, with some regions falling faster than others depending on their exposure to oil price volatility and any future geopolitical shocks.

Data approaches

Dealing with the present volatility via a multiasset correlated proxy hedging model was “great for quants” as it can give liquidity when it is needed and cover inflation risks by compiling a list of overlapping impact factors, including:

Commodities pricing:

as inflation tends to rise when oil prices do.

Currencies:

as inflation and interest rates – deployed as a mechanism to slow it – will directly feed into foreign exchange rates. Monitoring FX and building it into models using historical pricing and predictions is therefore advisable in any global investment strategy.

Inflation indexes:

also provide good historical data and metrics for a model.

These days we’ve got a lot more data to help with modelling, so we aren’t just reliant on traditional metrics such as these

commented a panellist.

Broadway ticket sales, illustrating consumer sentiment; emissions data, illustrating trends in manufacturing output; and so on are all very useful modern day data-led metrics. Combined with traditional data, the accuracy of inflation risk models should therefore go up in future years.

Artificial intelligence (AI) can help mine these non-traditional data streams more effectively as well, while also giving central banks another tool to improve their hitherto poor forecasting of inflation risk so far this decade. “ChatGPT and other generative AI tools might help with auto correlation modelling as well,” speculated another panellists.

Innovative use of financial products

Hedging options available to investors wanting to address inflation risk traditionally involve instruments like swaps and derivatives. But the panel presented some more innovative inflation protection products, such as:

Inflation-linked bonds:

In the US these can be linked to CPI or the RPI metric in the UK, which admittedly are not as liquid as nominal bonds but do provide protection against inflation risk, at a premium.

Zero coupon inflation swaps (ZCIS):

Whether in dollars, euro, pounds or other currencies, these can be shorter-term, enabling more proactive hedging than traditional monthly or longer-term options. “You can even make or see markets move with them,” commented one panellist.

Inflation options:

These are traditionally used for FX purposes, but they are very liquid and fast moving, so be careful if you use them to manage inflation (and associated FX) risk.