Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why the Fed Is Watching the Ten-Year Breakeven Rate Now
Transcript
- Lucas: Luna, I want to talk about a number that's been getting a lot of quiet attention at the Fed lately. It's not CPI, it's not PCE — it's the ten-year breakeven inflation rate. That ticked up to 2.28 percent as of yesterday. Luna: And for listeners who haven't tracked that — what exactly is the breakeven rate telling us that the regular inflation data isn't? Lucas: Right. So the breakeven is the difference between the yield on a regular ten-year Treasury note and the yield on a ten-year Treasury Inflation-Protected Security, or TIPS. It's the market's expectation of average annual inflation over the next decade. Luna: So when it goes up, it means bond traders expect higher future inflation. And it's been creeping higher even as core CPI and core PCE are actually declining. Lucas: Exactly. Core CPI for June came in at 336.1, down from 333.98 the prior month — that's disinflation. Core PCE ticked up a bit to 130.1, but still well below where we were a year ago. So you've got backward-looking data saying inflation is cooling, but forward-looking market data saying, maybe not so fast. Luna: That's the kind of divergence that makes the Fed's job harder. Which measure do they trust more? Lucas: Well, historically, the Fed has said they put a lot of weight on market-based inflation expectations because they're real-time and forward-looking. CPI and PCE are lagging indicators — they tell you what already happened. The breakeven tells you what bond investors think will happen. Luna: And right now, it's suggesting inflation expectations are not anchored at 2 percent. 2.28 percent is above the Fed's target. Lucas: Just barely, but yes. And it's moving in the wrong direction from the Fed's perspective. The ten-year breakeven was around 2.26 percent a few days ago, now it's 2.28. That's a two basis point move, but the trend matters more than the level. Luna: So what's driving it up? Is it the fiscal outlook? Import prices? The World Cup boost? Lucas: Probably a mix. Import prices from China just hit their highest since 2008 — that's a supply-side cost push. And the services sector has been sticky, as we've discussed before. But also, the breakeven can move on real yield moves. If nominal yields rise faster than TIPS yields, the breakeven expands. Luna: And we've seen the ten-year yield jump to 4.66 percent over the past five days. That's a big move. Lucas: Right. So part of that yield increase is probably about term premium — investors demanding more compensation for holding long-term debt with all the fiscal uncertainty. But part of it could be inflation expectations repricing higher. The Fed has to figure out which is which. Luna: If the breakeven keeps rising, does that make a rate cut less likely in September? Lucas: It complicates the case, for sure. The Fed has been signaling they're data-dependent, and if the data they're watching most closely — the breakeven — starts moving away from target, they'll be very hesitant to ease. Especially with the effective fed funds rate at 3.63 percent and the interest on reserve balances at 3.65. They're already in restrictive territory. Luna: So the breakeven is almost like a canary in the coal mine for the Fed's credibility. If the market doesn't believe they'll hit 2 percent, the breakeven will stay elevated. Lucas: Exactly. And that's why Fed watchers are parsing every word from officials like Kevin Warsh. He gave a speech recently and homed in on three key phrases — that's the kind of signal the market tries to decode for clues on how seriously they take these breakeven moves. Luna: I saw that headline. It's almost like a game of linguistic hot potato. But the breakeven is harder to spin — it's just numbers. Lucas: And that's why it's so powerful. You can massage CPI with seasonal adjustments, but the breakeven is what it is. It's the market voting with real money. Luna: Which brings us back to the core question: does the Fed need to hike again to bring breakevens down, or can they hold steady and let time do the work? Lucas: I think the current view at the Fed is that they can hold. The breakeven is only 28 basis points above target — that's not a panic number. But if it pushes toward 2.50 or higher, that's a different conversation. Luna: So what should listeners watch between now and the next FOMC meeting? Lucas: I'd say watch the daily breakeven ticks, but also watch the real yield. If TIPS yields are rising, that signals tight monetary policy is working. If nominal yields are rising but TIPS yields are flat, that's inflation expectations moving. Luna: And if the breakeven starts falling again, that would be a green light for a cut. Lucas: Exactly. That's the signal the market is waiting for. And speaking of signals that are useful — if today's breakdown of the breakeven rate helped make something click about how the Fed thinks, that's exactly the kind of thing we hope you get from this show. Luna: And the way we keep this ad-free and focused on the economics is through listener support. If you've gotten value from these conversations, you can help keep them going at buy me a coffee dot com slash fexingo. Lucas: It's a simple way to say this matters to you, and it really does make a difference. Now, back to the breakeven — one more nuance I want to add. The breakeven isn't a perfect measure. It includes a liquidity premium in TIPS, so sometimes it's elevated just because TIPS are less liquid than nominal Treasuries. Luna: That's a good point. So the Fed might not react to every blip. But the trend over several weeks — that's harder to dismiss. Lucas: Right. And right now, the trend is up. The five-day change in the ten-year yield is plus 1.9 percent, and the thirty-year is plus 1 percent. That's a steepening curve, which can also reflect inflation concerns. Luna: So if I'm a portfolio manager, I'm looking at the breakeven every morning alongside the jobs data and the CPI print. Lucas: Absolutely. In fact, some traders I've talked to say the breakeven is now their primary inflation indicator because it's real-time and market-clearing. CPI is almost a lagging sanity check. Luna: That's a shift from even a year ago, when everyone was glued to the monthly CPI release. Lucas: It is. And it reflects how the Fed itself has evolved. They've said repeatedly they're watching market-based measures closely. So the breakeven is essentially the market's report card on the Fed's inflation fight. Luna: And right now, the grade is a B minus. Not failing, but not an A. Lucas: That's a fair way to put it. And if the breakeven drifts higher, the Fed may have to remind the market that they're not done yet — through hawkish rhetoric or even a symbolic rate hike. But that's a bridge they'd rather not cross. Luna: So we'll keep watching that 2.28 number. Thanks, Lucas.