Summary
In this note we discuss the components of US breakevens and their evolution over time. Per D’Amico, Kim and Wei’s term structure decomposition, inflation expectations have recently bucked their persistent downward trend, but remain roughly target-consistent. Inflation risk premium appears very negative – this can be rational in an environment where weaker growth and weaker inflation is expected.
We then experiment with a fair value approach for assessing whether or not ten year breakevens are materially mispriced. Our approach has some plus points – deviations from “fair” are associated with subsequent changes in breakevens back towards fair, and the model fits the data very well overall. On the down side, the model suggests a substantial degree of time-variance in the relationships between breakevens and some of their drivers. We do not find evidence of material mispricing at present.
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