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What the Breakeven Inflation Rate Tells Investors

Byline profile imageWritten by Stephanie Colestock
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Byline profile imageEdited by Jeff White, CEPF®
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Inflation expectations can move markets long before actual prices show up in economic data. The breakeven inflation rate gives investors a way to see what the bond market is pricing in by comparing traditional Treasury yields with TIPS. Understanding this measure can help investors interpret inflation trends, interest-rate expectations and potential portfolio risks.

However you set up your portfolio, consider working with a financial advisor for an objective and informed perspective.

What Is the Breakeven Inflation Rate?

The breakeven inflation rate is a market-based estimate of expected inflation over a specific period. It is calculated by comparing the yield on a standard U.S. Treasury security with the yield on a Treasury Inflation-Protected Security (TIPS) of the same maturity. The difference between those yields represents the inflation rate at which an investor would theoretically earn the same return from either investment.

For example, if a 10-year Treasury yields 4.5% and a 10-year TIPS yields 2%, the 10-year breakeven inflation rate would be 2.5%. If inflation averages more than 2.5% over that period, TIPS would generally provide a better inflation-adjusted return, while inflation below that level would tend to favor the conventional Treasury.

Investors and economists often use breakeven rates as a gauge of the bond market’s inflation expectations. Rising breakeven rates can indicate that investors expect inflation to increase, while falling rates may suggest expectations for slower price growth.

However, the breakeven inflation rate is not a precise forecast of future inflation. Treasury and TIPS prices can also be affected by factors such as liquidity, investor demand and inflation risk premiums. As a result, breakeven rates are best viewed as one indicator that investors can use alongside economic data and other measures of inflation expectations.

Calculating the Breakeven Inflation Rate

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In order to calculate a breakeven inflation rate, one needs to simply compare the yield of an inflation-based bond (like TIPS) with a nominal bond of the same maturity period. The difference between how the two have performed during that time frame represents the breakeven inflation rate, or the rate that inflation would have to be for an investor to “break even” – or earn the same return – between purchasing TIPS or nominal Treasuries.

So, let’s say that you have a 10-year CD (certificate of deposit) that has yielded 5% over the course of the investment (nominal yield). You also hold an inflation-linked investment that has yielded 2.9% over the same time period (real yield).

Nominal yield – real yield = breakeven inflation rate

In this case, your breakeven inflation rate is 2.1% (5 – 2.9 = 2.1).

Why the Breakeven Inflation Rate Matters

So, what does this number actually mean? Take a look at the example above. This would indicate that over the next 10 years, today’s investors expect inflation to average around 2.1%. Of course, that number isn’t guaranteed. It’s simply an expectation based on the inflation rate of today and over the last 10 years.

Though it isn’t a guaranteed forecast, the breakeven rate can still be helpful to investors who want to outperform inflation.

Using that same example: if you believe that in the next 10 years, inflation will average more than 2.1%, you may want to consider purchasing Treasury inflation-protected securities (TIPS). If you believe that inflation will average less than 2.1% in the coming decade, a nominal Treasury might be the better choice for your portfolio.

Bottom Line

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The breakeven inflation rate gives investors a useful snapshot of how much inflation the bond market expects over a given period. By comparing nominal Treasury yields with TIPS yields, investors can assess inflation expectations and weigh the relative appeal of inflation-protected securities. Since market forces can influence the calculation, however, breakeven rates are most useful when considered alongside other economic and inflation indicators.

Tips on Inflation

  • Consider getting help from a financial advisor as you prepare your portfolio to withstand the effect of inflation. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Use our free inflation calculator to determine the buying power of a dollar over time in the United States.

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