There is a way to hedge directly against inflation, free from financial noise: Kalshi's CPIR1 market.

This market tracks the change in the Consumer Price Index (CPI). If the change in CPI that will be announced this Wednesday is above a certain threshold, you can make money on Kalshi's CPIR1 market. The three thresholds Kalshi provides are 0.3%, 0.4%, and 0.5%. In other words, if you buy Yes contracts in the market titled "Will the Consumer Price Index rise more than 0.5% in October?", and the CPI announced on Wednesday is above 0.5%, you will make money.

Depends on several factors, including your risk tolerance. Assume you’d like to purchase Yes contracts from the CPIR1 market. Here is what your purchasing power will look like if you hold the contracts at one of these targets versus only holding cash:

There are two portfolios shown above: one portfolio that only holds cash (red) and one portfolio that holds cash as well as Kalshi contracts from the CPIR1 market (green).

1) Purchasing power is lost as predicted inflation goes up. Imagine you have $100 in your portfolio. If inflation is 0.1% for instance, then your purchasing power decreases by 10¢. This is why there is a general downwards trend: both portfolios decrease in purchasing power as predicted inflation rate increases.

2) The cost of the Kalshi contracts is Price of Individual Contract * Number of Contracts Purchased. You will need to pay this amount when purchasing the contracts. So, before reaching the contract target threshold, the Kalshi portfolio (cash + contracts) is below the cash-only portfolio. You are taking a bit of risk to buy into this inflation hedge and that risk is the premium you paid to enter the trade or the “cost” of the contracts.

3) If inflation reaches the Kalshi contract target you select (i.e. 0.3%, 0.4%, or 0.5%), your Kalshi portfolio purchasing power will go up vertically. This is the payoff your receive from the contracts being correct. You'd basically be more 'rich' than if you held a purely cash portfolio, meaning you'd have shielded yourself from inflation - pretty neat

Purchasing more contracts will increase the deviation from the cash-only portfolio. This means you increase your risk (cost of contracts) and return (payoff from contracts).

And if you choose a smaller target, the threshold will simply shift to the left.

Note that the Yes contracts from a market with a lower target will likely cost more (i.e. Yes contracts at the 0.3% target are usually more expensive than Yes contracts at the 0.5% target). This is because a lower target is more likely to resolve to Yes in this market. A higher contract price will bring the Kalshi portfolio down towards the x-axis (shown below). This means the contracts cost more and payoff less. However, remember that if contracts cost more, the implied probability that they will resolve to Yes is likely higher.

Purchasing power was computed as follows: Cash * (1 - Predicted Inflation Rate) + Payoff or Cost of Kalshi contracts.

Payoff or Cost of Kalshi contracts = if the actual inflation rate is at or below the contract target target, then it’s: - 1 * Contract Price * Number of Contracts Purchased (cost of buying the contracts). If the inflation rate is above the target, then it’s: (1 - Contract Price) * Number of Contracts (payoff from contracts). You could also argue that the purchasing power of the Kalshi contracts should decline with higher inflation. This calculation was not included for simplicity.

Note: these calculations do not include all expenses, such as exchange fees and taxes.

On Wednesday (November 10th) the Bureau of Labor Statistics will announce the quarterly Consumer Price Index (CPI), a measure of inflation that’s calculated by looking at changes in price levels between a basket of goods.

To the individual, higher inflation means higher costs at the store. While companies are generally hedged against and able to withstand short term increases in inflation, prolonged inflation forces companies to pass on those costs to consumers. To the investor, higher inflation raises the price of commodities, decreases the value of bonds, erodes the value of the dollar, and​​ hurts growth equities such as tech stocks.

Historically, individuals looked to commodities like precious metals (specifically gold) and real assets such as real estate to hedge against inflation. However, the historical correlation between these assets and inflation is imperfect. For example, while conventional wisdom suggests buying gold during inflationary periods, gold’s actual correlation with inflation has only been 0.16 (out of 1) in the past half century. And although real estate provides a good hedge against inflation as one can raise rents typically Y/Y to adjust, the reality is that it’s not an asset class readily accessible to the average individual.

More recently, alternative investments like Bitcoin have been thought of as a modern way to hedge inflation. The appeal of cryptocurrency is that there is no central bank imposing monetary policy and that there is a finite supply of coins -- therefore suggesting it has inflation safe haven characteristics. However, the downside of using Bitcoin is that its price is driven by a multitude of factors which may make it an imperfect hedge.

Overall, Kalshi’s CPIR1 market is the most direct way to hedge against inflation. It was designed for the sole purpose of doing just that.

Note: the content of this article does not constitute professional or financial advice and is information of a general nature