Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why the Fed Is Watching the 10-Year Breakeven Inflation Rate
Transcript
- Lucas: So last week CPI came in at 334.0 — up another notch. Core CPI at 336.1. Headline writers had a field day: 'Inflation sticks around.' But here's the thing: the Fed barely blinked. Luna: Right, because they're looking past the backward-looking CPI to the market's own inflation read. The 10-year breakeven rate. Lucas: Exactly. As of July 10th, that breakeven sits at 2.24 percent — up just one basis point from the prior reading. The market is basically saying: inflation will average 2.24 percent over the next decade. That's almost exactly the Fed's target. Luna: So the Fed looks at that and thinks, 'We're fine.' Meanwhile, people see CPI at 334 and panic. Lucas: Yes, and that's the gap we need to bridge. The breakeven rate is the difference between the yield on a regular 10-year Treasury and the yield on a 10-year Treasury Inflation-Protected Security, or TIPS. The nominal yield is around 4.57 percent right now. The TIPS yield is about 2.33 percent. The difference — 2.24 percent — is the market's expectation for average annual inflation. Luna: And that's market-implied, not survey-implied. Real money behind it. Lucas: Right. The University of Michigan survey might show consumers expecting 3 percent inflation. But the breakeven says traders, with actual cash at stake, expect 2.24. The Fed trusts the market more. Luna: Because if traders are wrong, they lose money. Survey respondents just get a follow-up call. Lucas: Exactly. Now, 2.24 percent is not 2 percent. It's a bit above target. But it's not flashing alarm. And look at the trend: the breakeven has been hovering between 2.15 and 2.35 for most of 2026. No breakout. No collapse. Luna: So the Fed can afford to hold rates where they are. Fed funds at 3.63, flat since June. Lucas: Right. And that's the story. The breakeven gives the Fed cover to wait. They don't have to hike because inflation expectations are anchored. They don't have to cut because the economy isn't crashing — payrolls were soft at 57,000 in June, but unemployment is still only 4.2 percent. Luna: Though the participation rate falling to a 50-year low outside Covid is a wrinkle. Lucas: It is. But the breakeven doesn't capture labor supply. It captures inflation expectations. And those remain remarkably stable. Luna: Stable at 2.24. Which is not the same as stable at 2.00. Lucas: No, but the Fed has said they're willing to tolerate a bit above target if it means avoiding a recession. The breakeven gives them that room. Luna: So for listeners: if you want to know what the Fed is actually thinking, stop looking at the latest CPI print and start watching the breakeven rate. Lucas: Exactly. And to keep bringing you these kinds of insights without ads, a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo. That's literally what funds making this many episodes possible. Luna: If walking through the economy with us has made something click, that's the way to keep it going. Lucas: So back to the breakeven. One nuance: the TIPS market is not huge. About $2 trillion outstanding. Liquidity can distort the breakeven. During the 2020 Covid panic, the breakeven briefly went negative because TIPS prices went haywire. So the Fed takes it with a grain of salt. Luna: But as a signal, it's still cleaner than CPI? How so? Lucas: CPI measures what already happened. The breakeven measures what people expect. Monetary policy works on expectations. If the market expects 2.24 percent inflation over ten years, then long-term rates already embed that. The Fed doesn't need to shock the system. Luna: So the breakeven is essentially the market's vote of confidence in the Fed. Lucas: Exactly. And right now, that vote is a mild 'pass.' Not glowing, not failing. Which is why the Fed is in a holding pattern. Luna: And that holding pattern is showing up in the yield curve too. The 2-year yield at 3.69, the 10-year at 4.57 — still inverted. Lucas: Yes, but the inversion has narrowed. The spread is about 88 basis points. Not screaming recession like the 150 basis points we saw in 2023. The breakeven is part of that normalization. Real yields on TIPS are actually quite high historically — 2.33 percent is attractive for risk-free real return. Luna: So high real yields are tightening financial conditions without the Fed having to hike. Lucas: Exactly. The TIPS yield itself is a policy tool. If the Fed wants to tighten more, they can signal higher real rates. But the breakeven says they don't need to. Inflation expectations are docile. Luna: Docile but not dead. 2.24 is above 2. Lucas: True. And that's why no cuts are coming soon. The Fed needs to see the breakeven closer to 2.0 before they ease. Or they need a recession scare. Neither is happening now. Luna: So what could break the breakeven? What would make it spike or collapse? Lucas: A supply shock — oil spike, tariff war, crop failure — could push it above 2.5. That would force the Fed to hike. A financial crisis could collapse it below 1.5, and they'd cut. But right now, we're in the Goldilocks zone. Luna: And the Fed is happy to sit on their hands. Lucas: For now. But the participation rate drop is the one thing that could unsettle expectations. If workers keep leaving, wage pressure builds, and the breakeven might start creeping up. That's the risk. Luna: So the breakeven is stable, but it's not a guarantee. It's a snapshot of now. Lucas: Exactly. And as of July 11th, 2026, that snapshot says: inflation expectations are anchored. The Fed can wait. And that's the most important takeaway for anyone trying to guess the next rate move. Luna: So next time you see a hot CPI number, check the breakeven first. Lucas: Do that. And if you want to keep these breakdowns coming, you know where to find us.