Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Fed Watches the 10-Year Breakeven Rate Now
Transcript
- Lucas: So the 10-year breakeven rate just ticked down to 2.32 percent, from 2.34 last week. That's a tiny move, but for the Fed, this number is almost more important than the latest CPI print. Luna: Because it's a market-based measure of what investors actually expect for inflation, right? Lucas: Exactly. The breakeven is simply the difference between the yield on a regular 10-year Treasury and the yield on a 10-year Treasury Inflation-Protected Security, or TIPS. Right now, the ten-year yield is around 4.64 percent, and the TIPS yield is lower by that 2.32 percent gap. That's the market's inflation expectation over the next decade. Luna: And 2.32 percent is pretty much right on the Fed's 2 percent target, isn't it? Lucas: It's close, but the Fed actually prefers the five-year, five-year forward breakeven, which smooths out near-term noise. Still, the ten-year is a great barometer. And the fact that it's drifting lower while core CPI is still running at 3.4 percent year-over-year tells you the market is looking ahead, not at the rearview mirror. Luna: So the market is basically saying inflation will cool, even if the current data is sticky. Lucas: Right. And that's crucial for the Fed's credibility. If breakevens start climbing toward 3 percent, that's a red flag that the market doesn't trust the Fed to bring inflation down. But at 2.32, the Fed has room to keep rates on hold, which is where they are right now at 3.63 percent. Luna: And they've been holding steady for a bit. Does the breakeven help them decide when to cut? Lucas: It's one input. But here's the thing: the breakeven is also affected by supply and demand for TIPS, not just pure inflation expectations. So it's not a perfect measure. Still, when it moves in tandem with other indicators—like the University of Michigan survey or the New York Fed's survey of consumer expectations—it gives the Fed a cross-check. Luna: And those surveys have been pretty stable too, right? Lucas: Yeah, they've been hovering around 2.5 to 3 percent for the next one to three years, but the longer-term expectations have stayed anchored. That's the key. As long as long-run expectations are anchored, the Fed can look through short-term supply shocks, like the lettuce price crash we talked about a few weeks ago. Luna: That was a fun episode. But let's talk about why the breakeven is particularly in focus now, with the Treasury General Account stories floating around. Lucas: Right. So there's a headline that Treasury Secretary Bessent could tap into the nearly one trillion dollars in the Treasury General Account to fund bond buybacks. That's a big deal because it would directly affect the supply of Treasuries and TIPS, which in turn can distort breakevens. Luna: How so? Lucas: If the Treasury buys back bonds, they're reducing the outstanding supply of nominal Treasuries, which pushes those yields down. But if they also buy back TIPS, the effect on the breakeven depends on the relative amounts. It's a fine line to walk, and the market is watching closely to see if they actually pull the trigger. Luna: And there are folks like Druckenmiller who are skeptical that these ploys will work. Lucas: Yeah, Stanley Druckenmiller has been vocal about the bond market's fragility. If the Treasury tries to manipulate yields through buybacks, it could backfire if the market perceives it as monetizing debt. That would actually push long-term inflation expectations higher, which is the opposite of what the Fed wants. Luna: So the breakeven rate is kind of a stress test for Treasury actions. Lucas: Exactly. And right now, it's passing, but barely. The ten-year yield is at 4.64 percent, which is elevated, and the term premium is positive again. The Fed is walking a tightrope between supporting the economy—which is slowing, with real GDP growth at only 1.5 percent annualized—and keeping inflation expectations anchored. Luna: And the job market is starting to soften too, with job openings down to 7.36 million from 7.54 million. Lucas: Right, and unemployment ticked down to 4.1 percent, but payrolls shrank slightly. That's a mixed signal. The Fed has to balance that against the still-elevated core inflation. This is why the breakeven rate is such a handy shortcut: it tells you how the market is weighing all those factors in real time. Luna: So if the breakeven starts to rise even as the economy slows, that's a stagflation warning. Lucas: That's the nightmare scenario. But for now, the market seems to think the Fed can engineer a soft landing. The breakeven being just above 2 percent suggests that investors expect inflation to settle around the Fed's target in the long run, even if the path is bumpy. Luna: And speaking of the path, what's the next data point that could move the breakeven? Lucas: The next CPI report, obviously, but also the next jobs report and any Fed speeches. But one thing I'm watching is the Treasury's refunding announcement, which will detail buyback plans. If they actually start buying bonds, we could see a dip in yields, but the breakeven might react differently depending on the mix. Luna: And the breakeven is also influenced by oil prices and other commodity shocks, right? Lucas: Sure, but those tend to have a transitory effect. The 10-year breakeven is more about structural trends. That's why the Fed pays so much attention to it. It's a window into the market's collective judgment about the next decade. Luna: That's a good way to frame it. And it's a number that's easy to explain to anyone following the news. Lucas: Absolutely. And that's what we're here for—to make sense of these numbers. You know, we get a lot of questions from listeners about how to follow the economy without getting lost in the weeds. And honestly, the breakeven rate is one of those metrics that, once you get it, makes everything else click a bit more. Luna: It does. And if you're finding these conversations helpful, there's a small way you can support what we do. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these shows. Lucas: Yeah, no ads, no sponsors, just listener support. It keeps us independent and allows us to dive into these topics without any outside pressure. So if you're able, that's where to go. But either way, we're glad you're here. Luna: Now back to the breakeven—what's a realistic range for the Fed to be comfortable with? Lucas: Historically, anything between 2 and 2.5 percent is seen as consistent with the Fed's target. So at 2.32, they're in the sweet spot. But if it were to drop below 2 percent, that would signal deflation fears, which is also problematic. So they want it right around the target, not too hot, not too cold. Luna: It's a Goldilocks scenario. Lucas: Exactly. And right now, it's just about right. But the Fed can't rest easy. They have to keep communicating clearly, because as we've seen, one offhand remark can send breakevens swinging. It's a constant dance. Luna: And that's why we'll be watching that number every week. Lucas: For sure. And next week, we'll dig into what the August jobs report might look like, and whether the Fed will have enough evidence to hint at a September move. But for now, keep an eye on that breakeven rate—it's the canary in the coal mine.