Treasury breakeven rate
Fixed IncomeDefinition
The market's real-time forecast of average annual inflation over a given horizon. It is calculated by subtracting the yield on inflation-protected Treasuries (TIPS) from the yield on regular nominal Treasuries of the same maturity. The two most-watched are the 5-year breakeven (near-term inflation expectations) and the 10-year breakeven (long-run expectations).
How to read it: If the 10-year nominal Treasury yields 4.30% and the 10-year TIPS yields 1.90%, the 10-year breakeven is 2.40%. That means bond investors are pricing in 2.40% average annual inflation over the next decade. If actual CPI runs above 2.40%, TIPS will outperform nominal Treasuries; below 2.40%, nominal wins.
Why the Fed watches it: Breakevens are the cleanest market-based gauge of whether the Fed's 2% inflation target is credible. When 5-year breakevens drift above 2.5-3%, it signals investors no longer trust the Fed to control inflation. The Fed will often hike rates aggressively to push them back down. When breakevens collapse below 1.5%, it signals deflation fears - which is what triggered QE in 2008 and 2020.
Caveats: Breakevens include a small "inflation risk premium" (compensation for inflation uncertainty) and a "liquidity premium" (TIPS trade less actively than nominal Treasuries), so they are not a pure inflation forecast. But they are the closest thing the market gives you.
How to read it: If the 10-year nominal Treasury yields 4.30% and the 10-year TIPS yields 1.90%, the 10-year breakeven is 2.40%. That means bond investors are pricing in 2.40% average annual inflation over the next decade. If actual CPI runs above 2.40%, TIPS will outperform nominal Treasuries; below 2.40%, nominal wins.
Why the Fed watches it: Breakevens are the cleanest market-based gauge of whether the Fed's 2% inflation target is credible. When 5-year breakevens drift above 2.5-3%, it signals investors no longer trust the Fed to control inflation. The Fed will often hike rates aggressively to push them back down. When breakevens collapse below 1.5%, it signals deflation fears - which is what triggered QE in 2008 and 2020.
Caveats: Breakevens include a small "inflation risk premium" (compensation for inflation uncertainty) and a "liquidity premium" (TIPS trade less actively than nominal Treasuries), so they are not a pure inflation forecast. But they are the closest thing the market gives you.
Formula
Breakeven inflation = Nominal Treasury yield − TIPS yield (same maturity)
Example
In late 2022, the 5-year breakeven hit 3.6% as inflation peaked at 9%. By 2024, it had fallen back to 2.3% as the Fed's rate hikes regained credibility. A trader who shorted TIPS vs nominals when breakevens were at 3.6% made money as expectations normalized.