Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / What the 10-Year Breakeven Drop Means for the Fed
Transcript
- Lucas: So the 10-year breakeven inflation rate is down to 2.23 percent, as of yesterday. That's the lowest it's been since early 2024 — and it's been dropping pretty steadily since peaking above 2.45 back in April. Luna: And this is the market's forecast for average inflation over the next decade, right? So a drop like that is the bond market basically saying — we think the inflation fight is working. Lucas: Exactly. But here's the thing — the actual inflation data hasn't really cooperated. Core CPI for May came in at 336.1, up from 335.4 the month before. That's a 0.2 percent month-over-month increase. Not alarming, but not exactly 2 percent either. Luna: So the breakeven is falling even though realized inflation is still a little sticky. That's interesting. What's driving the disconnect? Lucas: Well, part of it is probably the oil price story. You've got headlines about potential Hormuz relief, and crude has pulled back. That drags down near-term inflation expectations, and the breakeven is heavily weighted toward the first few years. Luna: Right, because the breakeven isn't just about where inflation will be in year ten — it's the average over the whole period. So a big drop in energy prices today pulls down the whole average. Lucas: But I think there's something else going on, too. The fed funds rate is at 3.63 percent. Real GDP growth is only 1.6 percent annualized. The economy is growing below trend, and the labor market is sending mixed signals — job openings jumped to 7.6 million in April, but hiring is still sluggish. Luna: Yeah, that JOLTS number was a big surprise. Openings up by more than 700,000 from the prior month. But if companies are desperate to hire, why isn't payroll growth accelerating? Nonfarm payrolls only added about 170,000 in May. Lucas: That's the puzzle. And I think the bond market is looking at that and saying — the Fed has kept rates restrictive for over a year now. The real fed funds rate, if you subtract the breakeven, is about 1.4 percent. That's not extremely tight historically, but it's clearly slowing things down. Luna: So the breakeven drop could be the market's way of saying — the Fed is going to have to cut rates sooner than they thought, because the economy is softening. And lower inflation expectations give them room. Lucas: Right. But here's the counterargument — Kevin Warsh just chaired his first FOMC meeting last week. And the takeaway from that meeting was pretty hawkish. They held rates steady, and the statement didn't signal any urgency to cut. Luna: So the bond market is basically betting against the Fed's own guidance. That's a classic tension. Which one is right? Lucas: I don't think there's a clear answer yet. But I'd point to one number that gives me pause — the 10-year Treasury yield itself is at 4.51 percent, down about 4 basis points over the last five days. That's a pretty modest move. If the bond market really thought a recession was imminent, you'd expect yields to be falling faster. Luna: Because in a recession, investors pile into safe assets and yields drop. So the breakeven is falling, but nominal yields aren't collapsing. That suggests the move is more about inflation expectations than a growth scare. Lucas: Exactly. And that's actually a more nuanced signal. It means the bond market thinks the Fed's tight policy is working to bring inflation down — but without crashing the economy. The so-called soft landing scenario. Luna: But if the soft landing is priced in, why is the breakeven still above 2 percent? At 2.23, it's still above the Fed's target. So the market isn't convinced inflation will actually get back to 2 percent and stay there. Lucas: That's the rub. The breakeven says inflation will average 2.23 percent over the next decade. That's not exactly a victory lap. And if you look at the core PCE print — that's the Fed's preferred gauge — it came in at 129.6 for April, up from 129.3. That's running around 2.8 percent annualized. Luna: So realized core PCE is still well above the target, and the breakeven is saying it'll come down gradually but not all the way. That's a pretty reasonable middle ground, honestly. Lucas: It is. And I think that's the market's message — we're in this higher for longer regime, but not because the Fed wants to be. Because inflation is sticky, and the economy is just resilient enough to keep rates where they are. Luna: You know, it reminds me of something — if walking through the economy with us has made something click for you, there's a way to keep this kind of conversation going without any ads or sponsors. A handful of listeners already chip in monthly through Buy Me a Coffee, and that's literally what funds making this many episodes. Lucas: Yeah, it's a small group, but it makes a big difference. No pressure at all — just if you find value in the show and want it to stay ad-free, that's the way. It's Buy Me a Coffee dot com slash fexingo. Luna: Exactly. And we really mean it — no perks, no shout-outs, just the satisfaction of knowing you're keeping independent macro analysis alive. Anyway, back to the breakeven. Lucas: So where does that leave us? I think the key takeaway is that the 2.23 percent breakeven is a Goldilocks signal — not too hot, not too cold. It validates the Fed's cautious approach, but it doesn't give them a green light to cut. Luna: And it also means the bond market is somewhat at odds with the Fed's own dot plot, which probably shows no cuts this year. If the breakeven stays around here, the market might start pricing in a cut sooner than the Fed wants. Lucas: Right. And that's where the real tension lies. Because if the market prices in cuts and the Fed doesn't deliver, you could see a sharp repricing in bonds — which would tighten financial conditions anyway. Luna: So the breakeven itself becomes a policy input. The Fed has to watch it, because if it falls too fast, that could signal deflation risk. If it stays too high, it means inflation expectations are unanchored. Lucas: Exactly. And right now, 2.23 percent is kind of the sweet spot. But it's been dropping about 20 basis points over the last two months. If that trend continues, we could be looking at a breakeven below 2 percent by September — and that would be a whole different conversation. Luna: A breakeven below 2 percent would effectively be the market saying the Fed has overtightened. That would put real pressure on the Fed to cut, regardless of what the dot plot says. Lucas: And that's the scenario I'm watching. The next few months of CPI and PCE data will be critical. If core inflation stays around 0.2 percent month-over-month, the breakeven will probably stabilize. But if we get a couple of 0.1 percent prints, watch out below. Luna: So the breakeven is not just a number — it's a narrative. It encapsulates the market's view on the entire macro outlook. And right now, that narrative is 'cautiously optimistic but not convinced.' Lucas: That's a perfect way to put it. And I think that's the right stance for investors, too. The economy is in a weird place — not booming, not busting. The breakeven is telling us to stay nimble. Luna: All right, so next time we'll dig into the labor market puzzle some more — because those job openings aren't going to explain themselves. Lucas: Sounds like a plan. We'll see you then.