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Looking At Breakeven Rates - Is Inflation Subsiding?

Inflation is at the heart of our problems today. Prices are going up everywhere. My favorite chicken rice stall now sells a whole fully cooked chicken, which by the way has also shrunk in size, for $32. I am hoping this is temporary due to the ban on the export of live chickens from our dear neighbor. Just two years ago, it costs only $18. But in general, the prices of consumer goods and services are upward sticky. So in most cases, you are unlikely to see the food you eat, the coffee you drink, or the taxi fare you paid dropping in price in any meaningful way going forward. That is even if the raw commodities such as coffee beans or crude oil trading in the market come crashing down. That is why runaway inflation is a monster.

The Breakeven Inflation Rates

Is there anywhere we can get a sense of where inflation may be heading? Is it going to keep ramping up higher and higher? When will Fed's rate hike slow the demand down and have an impact on inflation? One place you can look at for possible clues is the Breakeven Inflation Rates and let the bond markets tell you what they think now.

The Breakeven Inflation Rates is the spread between the yields of the nominal Treasury bonds and their inflation-linked counterparts (TIPS) of the same maturity. The spread between these yields measures the expected inflation over the period considered. TIPS are issued in 5-year, 10-year, and 30-year maturities. Hence, the market tracks the 5-year, 10-year and 30-year breakeven inflation rates.

5Y Breakeven Inflation Rates Suggest A Peak in Inflation Is Coming?

5-year breakeven inflation rates vs year-on-year CPI inflation
5-year breakeven inflation rates vs year-on-year CPI inflation

This chart shows you how the 5Y breakeven inflation rates moved with the annual CPI inflation numbers. While not perfectly in sync, their trends are mostly in line. What is worth noting is that most of the time, the breakeven rate peaked one to six months before or at around the same time as the CPI numbers. The most recent peak in breakeven inflation rates occurs in March 2022. So we might be able to see a peak in the CPI numbers within the next 3 months if history holds. But of course, how much and how fast inflation falls then and whether it will come under another wave up will be a key to watch.

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