Thread by @VaradMarkets

#DiveIn: #Inflation Breakevens (BE)

Given immense focus on fiscal, monetary & inflation dynamics, quick brush up on Inflation BE:

BE = Nominal Rate, N (US Treasury Yield) – Real Rate, R (US Treasury Inflation Protected Securities, #TIPS Yields, T)

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https://twitter.com/VaradMarkets/status/1358019916075388928?s=20

BE = inflation level that makes investor indifferent b/w buying UST or TIPS
= (approx) market-based measure of risk neutral inflation expectations
= TIPS indexed to non-seasonally adjusted #CPI

10y BE = (10y Nominal Treasury yld) - (10y TIPS yld) = 1.16% - (-1.04%) = +2.20%

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Breakevens (from TIPS) actually do not capture pure inflation expectations

Nominal N = Short end Real + Term Premium + Inflation Expectation IE + Inflation Risk Premium IRP

TIPS Real R = Short end Real + Term Premium + Liquidity Premium LP

BE = N – R = IE + IRP – LP <> IE

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- IRP = Inflation Risk premium, especially in long end of curve = fear of higher-than-expected inflation

- LP = Liquidity Premium, extra illiquidity cost in TIPS market

BE also implied from Zero Coupon Inflation Swaps (IS)
BE = [(IS maturity / IS inception) ^ (1/n)] - 1

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Participants in TIPS Market
* Main Seller
- US Govt Auction (usually third Thursday every month)
* Others
- Real Money and Hedge Funds – view on BE, curve play
- Foreign Investors – generally outright buyers

Long Inflation = Buy TIPS + Sell Treasury UST = ⬇️Real + ⬆️Nominal

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Inflation v/s Oil:

Chart: 3y US CPI Inflation Swap v/s Brent Oil
- Oil yet to catch up?

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Market Based measure v/s Survey Based measure (Fed looks at both):

Chart: US Inflation Forward Breakeven 5y5y v/s U Michigan 5-10y Inflation Expectations
- Survey based measures generally more sticky

https://twitter.com/VaradMarkets/status/1350516108588056576?s=20

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@chigrl @bondstrategist
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