Measuring Market-Based Inflation Expectations

is the difference between the yields on constantmaturity nominal Treasury securities and Treasury Inflation-Protected Securities (TIPS). Payments on nominal securities are fixed. That is, they are not adjusted for inflation. Payments on TIPS are adjusted for inflation—specifically, changes in the consumer price index (CPI).1 This difference between nominal and inflation-adjusted (real) Treasury yields is sometimes called the breakeven inflation rate (BEI) because, if actual inflation comes in at the BEI rate, then holders of nominal and real Treasury bonds will get the same return. Because the BEI rate provides the same return and, thus, a risk-neutral investor would be indifferent between holding the two types of bonds, BEI is considered a forecast of future inflation. This easy-to-measure gauge of the Treasury market’s expectation for average inflation (over a given horizon) has been a boon to economists and policymakers since it was first introduced in the United States in the late 1990s.2 The figure shows the yields on nominal and real 5-year Treasury securities and the difference between those yields: that is, the five-year BEI that measures the bond market’s expectation of average inflation over the next five years. The vertical line marks March 13, the Friday before the FOMC meeting announcement on Sunday, March 15, 2020. Measuring Market-Based Inflation Expectations