Extracting Inflation Expectations from Treasury and TIPS Yield Curves
Update (08/22/2012): I have posted a similar but simplified method for calculating the breakeven rate here.
What level of inflation do market participants expect over the next 5, 10, or even 30 years? There are many methods of varying complexity that investors and policymakers use to estimate the level of expected inflation, but one relatively straightforward method is to examine the “breakeven” inflation rate which is the difference in interest rates between Treasuries and TIPS. This method has the advantage of being determined by market prices, so it reflects the views of investors who have money on the line.
A simple example illustrating the 5-year breakeven inflation rate is shown here:
